Ratio Analysis: ISC Class 12 Accounts Formulas, Notes and Solved Problems

What Ratio Analysis is about

Weightage: Ratio Analysis carries 8 of the 80 theory marks in Section B (Management Accounting). Candidates answer either Section B or Section C (20 marks each), after the compulsory 60-mark Section A.Source: CISCE ISC Accountancy (Accounts) syllabus, examination year 2027, distribution of marks

Key concepts

Liquidity ratios: current and quick

Current Ratio = Current Assets ÷ Current Liabilities

• Current Assets = Current Investments + Inventories (excluding loose tools and spare parts) + Trade Receivables (net of provision) + Cash and Bank Balance + Short-term Loans and Advances + Other Current Assets (prepaid expenses and accrued income only).
• Current Liabilities = Short-term Borrowings + Trade Payables + Other Current Liabilities + Short-term Provisions.

Quick (Liquid, Acid Test) Ratio = Quick Assets ÷ Current Liabilities, where Quick Assets = Current Assets − Inventories (excluding loose tools and spare parts) − Prepaid Expenses.

Interpretation: a higher ratio means better short-term liquidity, but a very high current ratio may mean idle cash, excess stock or slow collection from debtors: funds not earning a return. Express both as a pure ratio, for example 1.93 : 1, to two decimals.

Worked example

Suppose a company has inventories ₹2,40,000 (including loose tools ₹20,000), trade receivables ₹1,80,000 (net), cash ₹1,20,000, prepaid expenses ₹60,000, and current liabilities ₹3,00,000. Calculate the current and quick ratios. [2 marks]

Try it first, then show the solutionSolution

1. Current assets = 2,20,000 + 1,80,000 + 1,20,000 + 60,000 = ₹5,80,000; current ratio = 5,80,000 ÷ 3,00,000 = 1.93 : 1.
2. Quick assets = 5,80,000 − 2,20,000 − 60,000 = ₹3,00,000; quick ratio = 1 : 1.

Answer: Current ratio 1.93 : 1; quick ratio 1 : 1.

Solvency ratios

• Debt to Equity Ratio = Debt ÷ Equity. Debt = Long-term Borrowings + Long-term Provisions. Equity (Shareholders' Funds) = Share Capital + Reserves and Surplus, or Non-current Assets + Working Capital − Non-current Liabilities.
• Proprietary Ratio = Shareholders' Funds ÷ Total Assets (total assets include loose tools and spare parts).
• Debt to Total Assets Ratio = Debt ÷ Total Assets.
• Interest Coverage Ratio = Net Profit before Interest and Tax ÷ Fixed Interest Charges (interest on long-term borrowings only), in times.

A low debt to equity ratio means more safety for lenders, so creditors prefer lending to such companies; a high one means higher financial risk (but possibly higher returns to shareholders through trading on equity). Fresh equity raises the proprietary ratio and lowers the debt to total assets ratio.

Worked example

Suppose non-current assets are ₹9,00,000, working capital ₹2,50,000 and non-current liabilities (long-term borrowings ₹5,00,000 and long-term provisions ₹1,00,000) ₹6,00,000. Calculate the debt to equity ratio. [2 marks]

Try it first, then show the solutionSolution

1. Equity = 9,00,000 + 2,50,000 − 6,00,000 = ₹5,50,000.
2. Debt = ₹6,00,000; ratio = 6,00,000 ÷ 5,50,000 = 1.09 : 1.

Answer: 1.09 : 1.

Activity (turnover) ratios

• Trade Receivables Turnover = Credit Revenue from Operations ÷ Average Trade Receivables (receivables gross, before provision; include bills receivable). Credit revenue = revenue from operations − cash revenue.
• Trade Payables Turnover = Net Credit Purchases ÷ Average Trade Payables (creditors + bills payable).
• Inventory Turnover = Cost of Revenue from Operations ÷ Average Inventory. Cost of revenue = revenue − gross profit, or opening inventory + net purchases + direct expenses − closing inventory.
• Working Capital Turnover = Revenue from Operations ÷ Working Capital.

Average = (opening + closing) ÷ 2. All turnover ratios are expressed in times; examiners deduct marks when the unit is omitted.

Worked example

Suppose revenue from operations is ₹4,50,000, of which cash revenue is ₹1,50,000. Net closing trade receivables are ₹60,000 after a provision of ₹15,000, and opening gross receivables were ₹75,000. Calculate the trade receivables turnover ratio. [2 marks]

Try it first, then show the solutionSolution

1. Credit revenue = 4,50,000 − 1,50,000 = ₹3,00,000.
2. Closing gross receivables = 60,000 + 15,000 = ₹75,000; average = (75,000 + 75,000) ÷ 2 = ₹75,000.
3. Ratio = 3,00,000 ÷ 75,000.

Answer: 4 times.

Profitability ratios: gross, net, operating, operating profit

• Gross Profit Ratio = Gross Profit ÷ Revenue from Operations × 100.
• Net Profit Ratio = Net Profit (after tax) ÷ Revenue from Operations × 100 (syllabus: on net profit after tax).
• Operating Ratio: add cost of revenue from operations and operating expenses, deduct any operating income, divide by revenue from operations and multiply by 100 (formula sheet below). Operating expenses = employee benefit expenses + depreciation of tangible assets + selling and distribution + office and administrative expenses. Operating income = commission received, cash discount received.
• Operating Profit Ratio = Net Operating Profit ÷ Revenue from Operations × 100. Net operating profit = net profit after tax + provision for tax + non-operating expenses − non-operating incomes, or gross profit − operating expenses + operating income. Non-operating expenses: interest on long-term borrowings, loss on sale of non-current assets, amortisation of intangibles, capital losses written off. Non-operating incomes: interest and dividend on investments, profit on sale of non-current assets.

Operating ratio + operating profit ratio = 100%.

Worked example

Suppose revenue is ₹20,00,000, cost of revenue ₹14,00,000, operating expenses ₹3,30,000 and commission received ₹10,000. Calculate the operating ratio and operating profit ratio. [2 marks]

Try it first, then show the solutionSolution

1. Operating ratio = (14,00,000 + 3,30,000 − 10,000) ÷ 20,00,000 × 100 = 86%.
2. Operating profit = 6,00,000 − 3,30,000 + 10,000 = ₹2,80,000; ratio = 14%.

Answer: Operating ratio 86%; operating profit ratio 14% (they add to 100%).

EPS, P/E and return on investment

• Earning per Share = (Net Profit after Tax − Preference Dividend) ÷ Number of Equity Shares. EPS belongs to equity shareholders only: the denominator is the number of equity shares, not their amount.
• Price Earning Ratio = Market Value of an Equity Share ÷ Earning per Share, in times.
• Return on Investment = Net Profit before Interest and Tax ÷ Capital Employed × 100. Capital employed = Shareholders' Funds + Non-current Liabilities − Non-trade Investments (or non-current assets excluding non-trade investments + working capital). NPBIT excludes interest on non-trade investments.

When the ROI percentage is given, multiply capital employed by the rate once only (20% × 50,00,000), not by 20 and again by 100.

Worked example

Suppose net profit before interest and tax is ₹3,00,000; 10% debentures ₹5,00,000; tax 30%; 5% preference share capital ₹3,00,000; 60,000 equity shares of ₹10 each. Calculate EPS. [2 marks]

Try it first, then show the solutionSolution

1. Interest = ₹50,000; profit before tax = ₹2,50,000; net profit after tax = 2,50,000 × 70% = ₹1,75,000.
2. Preference dividend = 5% × 3,00,000 = ₹15,000.
3. EPS = (1,75,000 − 15,000) ÷ 60,000 = ₹2.67.

Answer: EPS ₹2.67 per equity share.

Effect of transactions on ratios

The syllabus restricts these questions to the current, quick and debt to equity ratios. Method: write the transaction as a journal entry, see which components change, then apply the rule:

• If a ratio is more than 1 and both numerator and denominator rise (or fall) by the same amount, the ratio falls (or rises).
• If a ratio is less than 1, the opposite.
• If both sides are unaffected, or one current asset replaces another of the same kind, there is no change.

Examples (current ratio 2 : 1): payment to creditors → both fall equally → ratio rises; purchase of goods on credit → both rise → ratio falls; sale of a non-current asset for cash (even at a loss) → current assets rise → ratio rises; salaries outstanding (expense not paid) → current liabilities rise → current and quick ratios fall.

Worked example

Suppose a company's quick ratio is 1.8 : 1. It sells a machine of book value ₹90,000 at a loss of ₹20,000. What is the effect on the quick ratio? [1 mark]

Try it first, then show the solutionSolution

1. Bank rises by ₹70,000 (a quick asset); current liabilities do not change.

Answer: The quick ratio improves.

Ratio Analysis in real life

Each concept, met in an everyday situation. Read the situation, answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Topics in this chapter

• Activity Ratios: Inventory, Receivables, Payables and Working Capital Turnover
• Liquidity Ratios: Current Ratio and Quick Ratio
• Profitability Ratios: Gross Profit, Net Profit, Operating Ratios, EPS, P/E and ROI
• Solvency Ratios: Debt-Equity, Proprietary, Debt to Total Assets, Interest Coverage

Ratio Analysis: key facts

Current Ratio

Current Assets ÷ Current Liabilities

Inventories exclude loose tools and spare parts; receivables net.

Quick Ratio

(Current Assets − Inventories − Prepaid Expenses) ÷ Current Liabilities

Debt to Equity

(Long-term Borrowings + Long-term Provisions) ÷ Shareholders' Funds

Proprietary Ratio

Shareholders' Funds ÷ Total Assets

Debt to Total Assets

Debt ÷ Total Assets

Interest Coverage

Net Profit before Interest and Tax ÷ Interest on Long-term Borrowings

Trade Receivables Turnover

Credit Revenue from Operations ÷ Average Trade Receivables (gross)

Trade Payables Turnover

Net Credit Purchases ÷ Average Trade Payables

Inventory Turnover

Cost of Revenue from Operations ÷ Average Inventory

Working Capital Turnover

Revenue from Operations ÷ Working Capital

Gross / Net Profit Ratio

Gross Profit (or Net Profit after Tax) ÷ Revenue from Operations × 100

Operating Ratio

(Cost of Revenue from Operations + Operating Expenses − Operating Income) ÷ Revenue from Operations × 100

Operating Profit Ratio

Net Operating Profit ÷ Revenue from Operations × 100

Earning per Share

(Net Profit after Tax − Preference Dividend) ÷ Number of Equity Shares

Price Earning Ratio

Market Value of an Equity Share ÷ Earning per Share

Return on Investment

Net Profit before Interest and Tax ÷ Capital Employed × 100

How the board asks Ratio Analysis

The question patterns to expect, and the method that works for each.

Tricks to remember Ratio Analysis

Short memory aids. Say each one aloud once, then use it on a question the same day.

• Units by family

  Liquidity and solvency: ": 1". Turnover and interest cover: "times". Profitability: "%". EPS: "₹".

  Use it when: Every answer.

• Loose tools: out of current, in total

  Exclude loose tools and spare parts from inventories for current/quick ratios; include them in total assets.

  Use it when: Current ratio and proprietary ratio.

• Ratio above 1: equal rise lowers it

  Above 1: same amount added to both sides pulls it down; subtracted pushes it up. Below 1: the reverse.

  Use it when: Effect of transactions.

Ratio Analysis: board-level solved questions

Ordered from board level to HOTS. Cover the solution, write your own, then compare step by step.

Case-study practice (Section A style)

Read the situation, then answer every part. In the board paper this is a 6-mark question split into 2 + 2 + 2 marks.

Where the marks are

How a typical answer is split into step marks. Show every step: a right final answer alone rarely earns full marks.

Where students lose marks in Ratio Analysis

The slips examiners see most often, and what to write instead.

• ✗Mistake: Gross versus net receivables; missing unit

  CISCE examiners' comments, 2025: "Did not add provision for doubtful debts back to get gross trade receivables."; "Omitted 'times' unit; abbreviated RFO."

  ✓Do this: Trade receivables turnover uses gross receivables; write "times" and full terms.

  Usually costs: ½-1 mark.

• ✗Mistake: Wrong numerator for ROI or double percentage

  CISCE examiners' comments, 2024: "Used Net profit after tax or before tax instead of Net Profit before Interest and Tax"; "Multiplied numerator by 100 and also used 20%, getting ₹ 10 crore".

  ✓Do this: ROI uses NPBIT; when the rate is a percentage, multiply capital employed by it once.

  Usually costs: 1-2 marks.

• ✗Mistake: EPS formula on the wrong base

  CISCE examiners' comments, 2025: "Wrote 'Net Profit after Tax and Dividend' or 'and Preference Shares' in formula instead of Preference Dividend."; "Used number of shares instead of number of equity shares."; CISCE examiners' comments, 2024: "Used incorrect formula for earning per share".

  ✓Do this: EPS = (Net Profit after Tax − Preference Dividend) ÷ Number of Equity Shares.

  Usually costs: 1 mark.

• ✗Mistake: Cost terms and opening inventory in the wrong place

  CISCE examiners' comments, 2025: "Wrote 'Cost of Goods Sold' or 'Revenue from Operations' in formula instead of cost of revenue from operations."; CISCE examiners' comments, 2024: "Used opening inventory to calculate current assets".

  ✓Do this: Use the syllabus wording; only closing inventory is a current asset.

  Usually costs: ½-1 mark.

• ✗Mistake: Ignoring the cash received when an asset is sold at a loss

  CISCE examiners' comments, 2024: "Said 'not change' because they did not add sale proceeds to quick assets".

  ✓Do this: Track the cash: sale proceeds raise quick assets even if there is a loss.

  Usually costs: 1 mark.

Practice questions on Ratio Analysis

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

1. Q1 · 1 mark · MCQBoard level

   Which ratio is expressed in times?
   (a) Proprietary ratio
   (b) Current ratio
   (c) Inventory turnover ratio
   (d) Gross profit ratio

   Hint

   Turnover.

   Answer

   (c)

2. Q2 · 1 mark · Very short answerBoard level

   Give the formula of interest coverage ratio as per the ISC syllabus.

   Hint

   Long-term interest only.

   Answer

   Net Profit before Interest and Tax ÷ Fixed Interest Charges (interest on long-term borrowings).

3. Q3 · 2 marks · Short answerHarder board level

   Revenue ₹4,50,000; cash revenue ₹1,50,000; net closing receivables ₹60,000 after provision ₹15,000; opening gross receivables ₹75,000. Calculate trade receivables turnover.

   Hint

   Gross receivables.

   Answer

   Credit revenue 3,00,000 ÷ average 75,000 = 4 times.

4. Q4 · 2 marks · Short answerHarder board level

   ROI is 18% and capital employed is ₹40,00,000. Give the formula and calculate the missing component.

   Hint

   Multiply once.

   Answer

   ROI = NPBIT ÷ Capital Employed × 100; NPBIT = 18% × 40,00,000 = ₹7,20,000.

5. Q5 · 2 marks · Short answerHarder board level

   Cash ₹8,00,000; short-term loans and advances ₹2,00,000; inventory ₹3,00,000; trade payables ₹6,00,000; cost of revenue ₹9,60,000; gross profit 25% on cost. Calculate working capital turnover.

   Hint

   Revenue = cost × 1.25.

   Answer

   Revenue = ₹12,00,000; working capital = 13,00,000 − 6,00,000 = ₹7,00,000; ratio = 1.71 times.

6. Q6 · 2 marks · Short answerHOTS / competency

   Current ratio is 2.5 : 1. State the effect of: (a) purchase of goods on credit; (b) payment of a bill payable.

   Hint

   Above 1.

   Answer

   (a) Both rise equally: ratio falls. (b) Both fall equally: ratio rises.

7. Q7 · 1 mark · Very short answerHarder board level

   Debt to equity is 0.8 : 1. What is the effect of issuing equity shares for cash?

   Hint

   Denominator.

   Answer

   Equity rises, debt unchanged: the ratio falls.

8. Q8 · 2 marks · Short answerHOTS / competency

   Net profit after tax ₹4,20,000; preference dividend ₹20,000; EPS ₹2.50; market price ₹30. Find the number of equity shares and the P/E ratio.

   Hint

   Rearrange EPS.

   Answer

   Shares = 4,00,000 ÷ 2.50 = 1,60,000; P/E = 30 ÷ 2.50 = 12 times.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1. 1.Net profit ratio uses which profit?Show answer

   Net profit after tax.

2. 2.Interest coverage counts which interest?Show answer

   Interest on long-term borrowings only.

3. 3.Other current assets in the syllabus?Show answer

   Prepaid expenses and accrued income only.

4. 4.Operating ratio + operating profit ratio = ?Show answer

   100%.

5. 5.Effect-of-transaction questions cover which ratios?Show answer

   Current, quick and debt to equity.

Quick revision checklist

The night before the exam: can you do each of these without looking?

• ☐Current ratio: loose tools out; receivables net.
• ☐Quick ratio: minus inventories and prepaid expenses.
• ☐Debt = long-term borrowings + long-term provisions.
• ☐Turnover ratios in times; receivables gross.
• ☐NP ratio after tax; operating ratio includes operating income deduction.
• ☐ROI excludes interest on non-trade investments.

Ratio Analysis: frequently asked questions