From the following, calculate (a) Debt-Equity Ratio (b) Total Assets to Debt Ratio (c) Proprietary Ratio. | Particulars | Amount (₹) | | --- | --- | | Equity Share Capital | 75,000 | | Share application money pending allotment | 25,000 | | General Reserve | 45,000 | | Balance in the Statement of Profit & Loss | 30,000 | | Debentures | 75,000 | | Trade Payables | 40,000 | | Outstanding Expenses | 10,000 |

> [!TLDR] > The Debt-Equity Ratio is 0.43:1, the Total Assets to Debt Ratio is 4:1, and the Proprietary Ratio is 0.58:1. Understanding a company's financial health involves looking at various aspects. The ratios you've asked to calculate — Debt-Equity Ratio, Total Assets to Debt Ratio, and Proprietary Ratio — are all **Solvency Ratios**. These ratios are crucial for assessing a company's long-term financial stability and its ability to meet its long-term obligations. They indicate the extent to which a company relies on borrowed funds versus owners' funds. Here's a breakdown of each ratio and its components: 1. **Debt-Equity Ratio:** This ratio establishes the relationship between long-term debt and shareholders' funds. It indicates the proportion of external long-term funds (debt) in comparison to internal funds (equity). A lower ratio generally suggests a more conservative financial structure, implying less risk for lenders. * **Debt** refers to long-term borrowings (e.g., debentures, long-term loans). It specifically excludes current liabilities. * **Equity** (or Shareholders' Funds) represents the owners' stake in the company. It includes Equity Share Capital, Preference Share Capital, Reserves and Surplus, and Share application money pending allotment. 2. **Total Assets to Debt Ratio:** This ratio measures the relationship between a company's total assets and its long-term debt. It indicates the extent to which assets are financed by long-term debt. A higher ratio implies that a larger portion of assets is financed by equity and current liabilities, suggesting better solvency. * **Total Assets** include all assets of the company, both current and non-current. * **Debt** is the same as defined for the Debt-Equity Ratio (long-term borrowings). 3. **Proprietary Ratio:** Also known as the Equity Ratio, this ratio shows the proportion of shareholders' funds in financing the total assets of the company. It indicates the extent to which

From the following, calculate (a) Debt-Equity Rati – Class 12 Accountancy

Numerical Questions · Q19

From the following, calculate (a) Debt-Equity Ratio (b) Total Assets to Debt Ratio (c) Proprietary Ratio.

Particulars	Amount (₹)
Equity Share Capital	75,000
Share application money pending allotment	25,000
General Reserve	45,000
Balance in the Statement of Profit & Loss	30,000
Debentures	75,000
Trade Payables	40,000
Outstanding Expenses	10,000

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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).

Important

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.

Watch out

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

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The Debt-Equity Ratio is 0.43:1, the Total Assets to Debt Ratio is 4:1, and the Proprietary Ratio is 0.58:1.

Understanding a company's financial health involves looking at various aspects. The ratios you've asked to calculate — Debt-Equity Ratio, Total Assets to Debt Ratio, and Proprietary Ratio — are all Solvency Ratios. These ratios are crucial for assessing a company's long-term financial stability and its ability to meet its long-term obligations. They indicate the extent to which a company relies on borrowed funds versus owners' funds.

Here's a breakdown of each ratio and its components:

Debt-Equity Ratio: This ratio establishes the relationship between long-term debt and shareholders' funds. It indicates the proportion of external long-term funds (debt) in comparison to internal funds (equity). A lower ratio generally suggests a more conservative financial structure, implying less risk for lenders.
- Debt refers to long-term borrowings (e.g., debentures, long-term loans). It specifically excludes current liabilities.
- Equity (or Shareholders' Funds) represents the owners' stake in the company. It includes Equity Share Capital, Preference Share Capital, Reserves and Surplus, and Share application money pending allotment.
Total Assets to Debt Ratio: This ratio measures the relationship between a company's total assets and its long-term debt. It indicates the extent to which assets are financed by long-term debt. A higher ratio implies that a larger portion of assets is financed by equity and current liabilities, suggesting better solvency.
- Total Assets include all assets of the company, both current and non-current.
- Debt is the same as defined for the Debt-Equity Ratio (long-term borrowings).
Proprietary Ratio: Also known as the Equity Ratio, this ratio shows the proportion of shareholders' funds in financing the total assets of the company. It indicates the extent to which the owners' funds are invested in the business. A higher ratio signifies a stronger financial position, as a larger portion of assets is financed by owners' capital rather than borrowed funds.
- Proprietary Funds (or Shareholders' Funds) are the same as Equity defined for the Debt-Equity Ratio.
- Total Assets are the same as defined for the Total Assets to Debt Ratio.

Watch out

A common mistake is to include current liabilities (like Trade Payables or Outstanding Expenses) when calculating 'Debt' for solvency ratios. Remember, 'Debt' in these ratios specifically refers to long-term debt only. Current liabilities are short-term obligations.

Let's now calculate the required components and then the ratios.

Given Information:

Particulars	Amount (₹)
Equity Share Capital	75,000
Share application money pending allotment	25,000
General Reserve	45,000
Balance in the Statement of Profit & Loss	30,000
Debentures	75,000
Trade Payables	40,000
Outstanding Expenses	10,000

Working Notes:

1. Calculation of Shareholders' Funds (Equity) …

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