Q.(a)
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🔒 Start your 14-day free trial to unlock the full solution →Part (a)Concept understanding — Ratio Analysis
Let’s start with something you already know. Suppose you and a friend both run small shops. You each put in ₹1,00,000. At the end of the year, your shop made a profit of ₹20,000; your friend’s shop made ₹30,000. Which shop is doing better? The obvious answer is your friend’s — more profit. But what if your friend had to borrow ₹2,00,000 to earn that ₹30,000, while you used only your own ₹1,00,000? Suddenly, your shop looks more efficient. You are now thinking in ratios: profit relative to the money used.
That is the core of Ratio Analysis. It is not about raw numbers; it is about relationships between numbers. A ratio is simply one figure divided by another. In accounting, we use ratios to judge a business’s performance, financial health, and efficiency — without being misled by size.
What the NCERT textbook says
The NCERT Class 12 Accountancy textbook (Part II, Chapter 5) defines Ratio Analysis as:
“Ratio Analysis is a technique of analysis of financial statements to assess the profitability, liquidity, solvency and efficiency of a business enterprise.”
It is a tool, not a separate account. You do not “debit” or “credit” a ratio. Ratios are calculated from the figures already recorded in the Trading and Profit & Loss Account and the Balance Sheet.
Why does it matter?
Three big reasons:
- Comparison – You can compare a small firm with a large one, or the same firm over different years, because ratios cancel out size.
- Decision-making – A bank deciding whether to give a loan looks at liquidity ratios. An investor looks at profitability ratios.
- Early warning – A falling current ratio may signal trouble paying bills, even if profits look fine.
Accounting treatment: No debit/credit
This is a common confusion. Ratio Analysis is not a journal entry. You never write:
“Debit Ratio Analysis, Credit Profit & Loss Account”
That would be wrong. Ratios are computed after the final accounts are prepared. They are presented in a separate statement called a Comparative Statement or Common Size Statement, or simply listed in a report.
Where a format/proforma is given
The NCERT textbook gives a format for Comparative Balance Sheet and Comparative Statement of Profit & Loss. These are the main vehicles for ratio analysis. Here is the proforma for a Comparative Balance Sheet as per NCERT:
| Particulars | Note No. | Previous Year (₹) | Current Year (₹) | Absolute Change (₹) | Percentage Change (%) |
|---|---|---|---|---|---|
| I. EQUITY AND LIABILITIES | |||||
| 1. Shareholders’ Funds | |||||
| (a) Share Capital | |||||
| (b) Reserves and Surplus | |||||
| 2. Non-Current Liabilities | |||||
| (a) Long-term Borrowings | |||||
| 3. Current Liabilities | |||||
| (a) Trade Payables | |||||
| (b) Short-term Provisions | |||||
| Total | |||||
| II. ASSETS | |||||
| 1. Non-Current Assets | |||||
| (a) Fixed Assets | |||||
| (b) Non-Current Investments | |||||
| 2. Current Assets | |||||
| (a) Inventories | |||||
| (b) Trade Receivables | |||||
| (c) Cash and Cash Equivalents | |||||
| Total |
Part (b)Concept understanding — Liquidity Ratio Analysis
Liquidity Ratio Analysis – A First Look
Think of your own pocket money. You get ₹500 at the start of the month. You know you'll need to pay ₹200 for a bus pass, ₹150 for stationery, and ₹100 for a friend's birthday gift. That's ₹450 of definite expenses. You have ₹500 cash in hand. You can easily cover those payments. That's liquidity – your ability to meet short-term obligations as they fall due.
Now imagine you have a ₹10,000 fixed deposit that matures in two years, but you need ₹500 today. You can't break the FD easily without a penalty. That asset is not liquid enough for today's need. Liquidity is about timing – having cash or near-cash when the bill arrives.
The Precise Meaning in Accountancy
In a business, liquidity means the firm's ability to pay its current liabilities (debts due within one year) using its current assets (assets that can be converted into cash within one year). The two most important ratios from NCERT Class 12 (Part B, Chapter 5 – Accounting Ratios) are:
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio (Acid Test Ratio) = Quick Assets / Current Liabilities
Where:
- Current Assets include: Cash, Bank, Debtors, Bills Receivable, Inventory, Prepaid Expenses, Short-term Investments.
- Current Liabilities include: Creditors, Bills Payable, Outstanding Expenses, Short-term Loans, Bank Overdraft.
- Quick Assets = Current Assets – Inventory – Prepaid Expenses (because inventory takes time to sell, and prepaid expenses cannot be converted to cash).
The ideal current ratio is 2:1 (₹2 of current assets for every ₹1 of current liability). The ideal quick ratio is 1:1. These are benchmarks, not rigid rules – a trading firm with fast-moving inventory can survive with a lower current ratio.
Why It Matters
A business that cannot pay its short-term debts is technically insolvent – even if it owns huge factories. Creditors, banks, and suppliers check these ratios before giving credit. A very high ratio (say 5:1) may mean idle cash or poor asset utilisation. A very low ratio (say 0.8:1) signals danger – the firm may default.
A high current ratio is not always good. If it comes from slow-moving inventory or old debtors, the firm may still struggle to pay cash. That's why the quick ratio is a stricter test.
Accounting Treatment – No Direct Journal Entry
Liquidity ratios are not recorded in the books of accounts. They are calculated from the Balance Sheet for analysis. There is no debit or credit entry for a ratio. The treatment is purely analytical:
- You take the Balance Sheet (prepared under Schedule III of Companies Act, 2013).
- Identify current assets and current liabilities from the prescribed format.
- Compute the ratios.
However, the components of these ratios do have accounting entries. For example, when you buy goods on credit:
- Debit Purchases A/c
- Credit Creditors A/c
This increases inventory (current asset) and creditors (current liability), affecting the current ratio. But the ratio itself is never journalised.
Format from NCERT – Balance Sheet Extract (Schedule III)
Below is the relevant part of the Balance Sheet format used to compute liquidity ratios. Only the current portions are shown.
| Particulars | Note No. | Amount (₹) |
|---|---|---|
| ASSETS | ||
| 1. Non-current Assets | ||
| (a) Property, Plant & Equipment | 1 | xxx |
| (b) Intangible Assets | 2 | xxx |
| 2. Current Assets | ||
| (a) Inventories | 3 | xxx |
| (b) Trade Receivables | 4 | xxx |
| (c) Cash & Cash Equivalents | 5 | xxx |
| (d) Short-term Loans & Advances | 6 | xxx |
| (e) Other Current Assets | 7 | xxx |
| Total Assets | xxxx | |
| EQUITY & LIABILITIES | ||
| 1. Shareholders' Funds | ||
| (a) Share Capital | 8 | xxx |
Part (a) — Revenue from Operations & Trade Payables Turnover Ratio
- Revenue from Operations Cost of Revenue from Operations = Inventory Turnover Ratio × Average Inventory = 8 × 1,20,000 = ₹9,60,000. Profit is 20% on revenue, so Cost = 80% of Revenue → Revenue = 9,60,000 ÷ 0.80 = ₹12,00,000.
- Trade Payables Turnover Ratio
| Date | Creditors (₹) | Bills Payable (₹) | Trade Payables (₹) |
|---|---|---|---|
| 01.04.2024 | 3,00,000 | 2,00,000 | 5,00,000 |
| 31.03.2025 | 4,80,000 | 2,20,000 | 7,00,000 |
Average Trade Payables = (5,00,000 + 7,00,000) ÷ 2 = ₹6,00,000. …
Part (a): Revenue from Operations = ₹12,00,000; Trade Payables Turnover Ratio = 4 times.
Part (b): Quick Ratio = 1.4 : 1; Working Capital Turnover Ratio = 4.8 times.
Part (a)
- Revenue from Operations Inventory Turnover Ratio = Cost of Revenue from Operations ÷ Average Inventory. Cost = 8 × 1,20,000 = ₹9,60,000. Profit is 20% on Revenue from Operations, so Cost = 80% of Revenue. Revenue from Operations = 9,60,000 ÷ 0.80 = ₹12,00,000.
- Trade Payables Turnover Ratio Trade Payables = Creditors + Bills Payable.
| Date | Creditors (₹) | Bills Payable (₹) | Trade Payables (₹) |
|---|---|---|---|
| 01.04.2024 | 3,00,000 | 2,00,000 | 5,00,000 |
| 31.03.2025 | 4,80,000 | 2,20,000 | 7,00,000 |
Average Trade Payables = (5,00,000 + 7,00,000) ÷ 2 = ₹6,00,000. …
Showing the 12 most recent of 86 on this concept.
- CBSE 2026Set 67/3/11 markMCQQ.(a) Which of the following is a financial statement of a company ? (A) Common Size Statement of Profit and Loss (B) Statement of Profit and Loss (C) Comparative Balance Sheet (D) Comparative Statement of Profit and Loss(OR)(b) Which of the following is not a Solvency Ratio ? (A) Debt-Equity Ratio (B) Return on Investment (C) Interest Coverage Ratio (D) Proprietary Ratio
›Reveal solutionSolution
Part (a): (B) Statement of Profit and Loss is a financial statement; the others are analytical tools. Part (b): (B) Return on Investment is a profitability ratio, not a solvency ratio.
Part (a)
Under the Companies Act, 2013 the financial statements are the primary, statutory statements: the Balance Sheet, the Statement of Profit and Loss, and the Cash Flow Statement. Common Size and Comparative statements are analytical statements prepared from the financial statements for interpretation.
Option Nature (A) Common Size Statement of P&L Analytical tool (B) Statement of Profit and Loss Financial statement ✓ (C) Comparative Balance Sheet Analytical tool - CBSE 2026Set 67/3/11 markMCQQ.The Current Ratio of Megh Raj Ltd. is 1·5 : 1. Which of the following transactions will reduce the ratio ? (A) Sale of furniture of ₹ 18,000 at a loss of ₹ 2,000 (B) Goods purchased on credit ₹ 75,000 (C) Sale of goods costing ₹ 60,000 for ₹ 80,000 (D) Payment of trade payables ₹ 40,000
›Reveal solutionSolution
The transaction that will reduce the Current Ratio (from 1.5:1) is (B) Goods purchased on credit ₹ 75,000, because it increases current assets and current liabilities by the same amount, which lowers a ratio greater than 1:1.
Concept First: Why the Current Ratio Changes
The Current Ratio is Current Assets ÷ Current Liabilities. Megh Raj Ltd. has a ratio of 1.5:1 — meaning for every ₹1 of current liability, the firm holds ₹1.50 of current assets. This is a ratio greater than 1:1.
Here is the key rule you must remember:
ImportantWhen a ratio is greater than 1:1, adding an equal amount to both numerator (current assets) and denominator (current liabilities) reduces the ratio. When a ratio is less than 1:1, the same transaction increases the ratio.
Why? Think of it as a fraction. If you have 3/2 = 1.5, and you add 1 to both top and bottom, you get 4/3 ≈ 1.33 — which is smaller. The same logic applies to any transaction that increases both current assets and current liabilities by the same rupee amount.
Now let us examine each option.
Analysing Each Transaction
Option (A): Sale of furniture of ₹ 18,000 at a loss of ₹ 2,000
Furniture is a non-current asset (fixed asset). Selling it converts it into cash (a current asset). The book value of the furniture is ₹ 20,000 (since loss of ₹ 2,000 on sale of ₹ 18,000 means cost was ₹ 20,000).
- Effect on Current Assets: Cash increases by ₹ 18,000.
- Effect on Current Liabilities: No change.
- Effect on Current Ratio: Numerator increases, denominator unchanged → Ratio increases.
So (A) does not reduce the ratio.
Option (B): Goods purchased on credit ₹ 75,000
- Effect on Current Assets: Inventory (stock) increases by ₹ 75,000.
- Effect on Current Liabilities: Trade payables (creditors) increase by ₹ 75,000.
- Effect on Current Ratio: Both numerator and denominator increase by the same amount (₹ 75,000). Since the original ratio is 1.5:1 (>1:1), this reduces the ratio.
Let us verify with numbers. Suppose original current assets = ₹ 1,50,000 and current liabilities = ₹ 1,00,000 (ratio = 1.5:1). After the transaction:
Current assets = ₹ 1,50,000 + ₹ 75,000 = ₹ 2,25,000
Current liabilities = ₹ 1,00,000 + ₹ 75,000 = ₹ 1,75,000
New ratio = 2,25,000 ÷ 1,75,000 = 1.2857:1 — which is lower than 1.5:1.
So (B) reduces the ratio.
Watch outA common mistake is to think that any increase in current liabilities reduces the ratio. That is only true if current assets do not also increase. Here, both increase equally, so the effect depends on whether the original ratio is above or below 1:1.
Option (C): Sale of goods costing ₹ 60,000 for ₹ 80,000
This is a credit sale (or cash sale — either way, the effect is the same on current assets and liabilities).
- Effect on Current Assets:
- Inventory decreases by ₹ 60,000 (cost of goods sold).
- Debtors (or cash) increase by ₹ 80,000 (sale price).
- Net increase in current assets = ₹ 80,000 – ₹ 60,000 = ₹ 20,000.
- Effect on Current Liabilities: No change (assuming no credit purchase involved). …
- CBSE 2026Set 67/4/11 markMCQQ.(a) Which of the following statements are correct ? I. A low current ratio endangers the business and puts it at risk of facing a situation, where it will not be able to pay its short-term debts on time. II. Trade payables turnover ratio expresses the relationship between net credit sales and average trade payables. III. Operating profit ratio plus Gross profit ratio = 100. IV. Inventory turnover ratio determines the number of times inventory is converted into revenue from operations during the accounting period under consideration. Options : (A) I and II (B) II and III (C) III and IV (D) I and IV(OR)(b) Ratios that are calculated for measuring the efficiency of operations of business based on effective utilisation of resources are called : (A) Turnover ratios (B) Profitability ratios (C) Solvency ratios (D) Liquidity ratios
›Reveal solutionSolution
Part (a): statements I and IV are correct - option (D). Part (b): turnover ratios measure operating efficiency - option (A).
Part (a)
Statement Verdict Reason I - low current ratio risks short-term default Correct Current ratio = CA / CL; a low value means weak short-term solvency II - payables turnover = net credit sales / avg payables Incorrect It uses net credit purchases; sales are used for receivables turnover III - Operating profit ratio + Gross profit ratio = 100 Incorrect Operating profit = Gross profit - Operating expenses; they never sum to 100 IV - inventory turnover = times inventory converted to revenue Correct Inventory turnover = Cost of revenue / Average inventory - CBSE 2026Set 67/5/11 markMCQQ.(a) From the following information obtained from the books of accounts of Ananda Ltd., calculate ‘Quick Ratio’ of the company : Total Current Assets (including stock and prepaid expenses) ₹ 2,00,000; Stock ₹ 20,000; Prepaid expenses ₹ 10,000; Current liabilities ₹ 1,70,000. (A) 20 : 17 (B) 1 : 1 (C) 18 : 17 (D) 19 : 17(OR)(b) ‘Analysis of financial statements is useful and significant to different users.’ Which of the following users is concerned with a firm’s long-term solvency and survival ? (A) Labour unions (B) Trade payables (C) Finance manager (D) Lenders
›Reveal solutionSolution
(a) Quick Ratio of Ananda Ltd. = 1 : 1 → option (B).
(b) The user concerned with long-term solvency and survival is Lenders → option (D).
Part (a)
The Quick (Acid-Test) Ratio measures the ability to meet current liabilities from the most liquid assets, excluding Stock and Prepaid Expenses (which are not readily convertible to cash).
Quick Assets = Current Assets − Stock − Prepaid Expenses = 2,00,000 − 20,000 − 10,000 = ₹1,70,000 …
- CBSE 2026Set 67/5/11 markMCQQ.The following information is obtained from the books of Devdutt Ltd. : Working capital – ₹ 4,00,000 Trade Payables – ₹ 50,000 Other Current liabilities – ₹ 1,00,000 Current assets of Devdutt Ltd. are : (A) ₹ 2,50,000 (B) ₹ 4,50,000 (C) ₹ 5,00,000 (D) ₹ 5,50,000
›Reveal solutionSolution
The Current Assets of Devdutt Ltd. are calculated as ₹ 5,50,000 by using the working capital formula.
Understanding a company's liquidity position is crucial for assessing its short-term financial health. One of the primary tools for this assessment is Liquidity Ratio Analysis, which includes calculating ratios like the Current Ratio and the Quick Ratio, and also understanding key components like Working Capital.
Working Capital represents the excess of current assets over current liabilities. It indicates the funds available to a business for its day-to-day operations after meeting its short-term obligations. A positive working capital signifies that a company has enough current assets to cover its current liabilities, suggesting good short-term solvency.
The fundamental formula for Working Capital is:
Working Capital = Current Assets - Current Liabilities
In this question, we are given the Working Capital and the components of Current Liabilities. Our goal is to determine the Current Assets. We can rearrange the formula to solve for Current Assets:
Current Assets = Working Capital + Current Liabilities
Let's break down the calculation.
Working Notes
-
Calculation of Total Current Liabilities:
Current Liabilities are obligations that are expected to be settled within one year or the operating cycle of the business, whichever is longer.
- Trade Payables = ₹ 50,000
- Other Current Liabilities = ₹ 1,00,000 Total Current Liabilities = Trade Payables + Other Current Liabilities Total Current Liabilities = ₹ 50,000 + ₹ 1,00,000 = ₹ 1,50,000
-
Calculation of Current Assets:
Now that we have the total current liabilities and the working capital, we can find the current assets using the rearranged formula. …
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- CBSE 2026Set MARCH1 markMCQQ.For which of the following items the ratio is computed in days?(a) For total purchase(b) For credit sales(c) For credit purchase(d) Both (B) and (C)
›Reveal solutionSolution
Ratios computed in days apply to both credit sales and credit purchases, so the answer is (d).
Certain activity ratios are stated as a number of days:
Ratio Based on Expressed in Debtors / Receivables collection period Credit sales Days Creditors / Payables payment period Credit purchases Days … - CBSE 2026Set MARCH1 markMCQQ.Which of the following is correct for accounting ratios?(a) Comparison with ratios developed by the firm(b) Comparison with ratios of industry(c) Comparison with ratios of competitors(d) All of the above
›Reveal solutionSolution
Accounting ratios can be compared with the firm's own, industry and competitors' ratios, so the answer is (d).
Ratio analysis is a comparative tool. A ratio is judged good or bad only against a benchmark, which may be:
- the firm's own ratios of earlier years (intra-firm/trend comparison),
- the average ratios of the industry, and …
- CBSE 2026Set MARCH1 markQ.Will the current ratio increase or decrease when the current assets increase and the current liabilities remain unchanged?
›Reveal solutionSolution
If current assets rise and current liabilities stay the same, the current ratio increases.
Current Ratio = Current Assets / Current Liabilities.
When current assets increase and current liabilities are unchanged, the numerator becomes larger while the denominator is constant, so the value of the ratio rises.
…
- CBSE 2026Set MARCH1 markQ.Expand R.O.I.
›Reveal solutionSolution
R.O.I. stands for Return on Investment.
Return on Investment (also called Return on Capital Employed) is a profitability ratio that shows how efficiently the capital employed in the business has been used to generate profit.
…
- CBSE 2026Set ANNUAL1 markMCQQ.Gayatri Limited's current ratio is 0.5 : 1. What will the effect on the current ratio, if goods purchased for cash? A) Will increase B) Will decrease C) Cannot be determined D) No change
›Reveal solutionSolution
A cash purchase of goods leaves the current ratio unchanged - option (D).
Current ratio = Current Assets / Current Liabilities. When goods are bought for cash:
- Inventory (a current asset) increases.
- Cash (a current asset) decreases by the same amount.
The two effects cancel, so total current assets stay the same, and current liabilities are not affected at all. With both numerator and denominator unchanged, the ratio stays at 0.5 : 1.
…
- CBSE 2026Set ANNUAL1 markMCQQ.If the market price of a company is ₹ 16 per share and earning per share is ₹ 3.2, then the price earning ratio will be A) ₹ 0.20 B) ₹ 5 C) ₹ 16 D) Cannot be determined
›Reveal solutionSolution
The price-earning ratio is 5 - option (B).
Price-Earning (P/E) Ratio = Market Price per Share / Earnings per Share (EPS)
= 16 / 3.2
= 5 times.
…
- CBSE 2026Set ANNUAL1 markMCQQ.Assertion(A) : Accounting ratio is a mathematical expression of relationship between different items of the group of items in the Financial Statements for two consecutive years. Reason (R) : Accounting ratio is a mathematical expression of relation between two items of the group of items in the Financial Statement. In the context of the above statements, which of the following is correct?(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A)(c) Assertion (A) is true but Reason (R) is false(d) Assertion (A) is false but Reason (R) is true(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A)(c) Assertion (A) is true but Reason (R) is false(d) Assertion (A) is false but Reason (R) is true
›Reveal solutionSolution
Assertion (A) is false but Reason (R) is true (Option D).
An accounting ratio is simply a mathematical expression of the relationship between two related items (or groups of items) taken from the financial statements of the SAME accounting period — for example, Current Assets to Current Liabilities, or Net Profit to Revenue from Operations, both for the same year. It does not require, and is not defined using, figures 'for two consecutive years' as stated in Assertion (A); ratios for two different years are only needed when doing trend/comparative analysis of the SAME ratio across years, which is a separate exercise from the basic defini …
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