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Accounting Ratios – RBI Grade B Notes for Finance & Management

Accounting Ratios - RBI Grade B Notes

Reserve Bank of India being the central bank of the country is a great organisation to work for. Every year Lakhs of aspirants apply for the RBI Grade B posts as it offers great career opportunities as well as impressive perks & allowances to its officers. The Grade B recruitment notification is expected to be announced in the month of June 2019 most probably. It is highly advisable to start with your preparations from now on itself so that when you are suddenly notified of the recruitment notification, you have already covered a prominent portion of the syllabus. The Grade B Exam is conducted in three stages namely Phase I, Phase 2 and the Interview round.

Toppers of the exam have always suggested to carry on the preparations and study for both Phase 1 and Phase 2 simultaneously because the syllabus of the Phase 2 of RBI Grade B is vast and requires thorough knowledge and persistence in studies. The subjects asked in the Phase 2 Exam are Economics & Social Issues, Finance & Management and Descriptive English. So to give you a helping hand in your studies for the Grade B Exam, we at Oliveboard would be providing you study notes on important topics from the syllabus of Phase 2. In this blog we will cover the topic of Accounting Ratios – RBI Grade B Notes.

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Accounting Ratios – RBI Grade B Notes for Finance & Management

The Finance & Management paper of RBI Grade B Exam comes in either 55:45 or 45:55 or 50:50 in terms of weightage for Finance to Management. Thus, both the subjects are roughly of equal importance. While the Finance Part contains Numerical of around 10-15 marks, the most recent exam had only one numerical. Progressively the numericals have declined over the years. But one should keep in mind that these patterns can be altered and all the numericals need to be learnt & Practice.

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Accounting Ratios – RBI Grade B Notes

Financial Analysist’s world depends on financial statements for the performance of the companies but if one compares other entities alongside the size of the statements it poses a problem.

Then Financial or Accounting Ratios come to their rescue. Ratio is a Mathematical relationship between two numbers.

Accounting Ratios can be divided into categories

  1. Liquidity Ratios
  2. Leverage Ratios
  3. Turnover Ratios
  4. Profitability Ratios
  5. Valuation Ratios

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We would learn these ratios one by one below:

1. Liquidity Ratios:

Time period here is short generally 1 year. These are based on the relationship between current assets and current liabilities. There are three types of Liquidity ratios Current ratio, Acid-test ratio, and Cash ratio.

 (a) Current Ratio: It is the Ratio of Current assets to Current Liabilities

 Current Ratio = Current Assets / Current Liabilities.

 Significance: The current ratio tells us the ability of the firm to meet its current liabilities for the next 1 year.

Current assets include cash, current investments, debtors, inventories (stocks), loans and advances, and pre-paid expenses while Current liabilities loans and provisions.

(b) Acid-test Ratio/quick ratio: It is the ratio of Quick Assets to Current Liabilities.

 Acid test ratio =Quick assets /Current liabilities.

Quick Assets are current assets without inventories as inventories are least liquid in current assets.

(c) Cash Ratio

Cash ratio =(Cash and bank balances + Current investments ) / Current liabilities

This is the measure of most liquid assets to the current liabilities.

All the above measure liquidity in different forms and ranges.

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2. Leverage Ratios:

These ratios help us to calculate risk from the use of debt as capital. Two types of ratios are commonly used to analyse financial leverage: Structural ratios and Coverage ratios.

(a) Structural Ratios:

(i) Debt-equity ratio: It is the ratio of Debt to Assets which shows the relative contributions of creditors and owners.

Debt-Equity Ratio = Total Liabilities​ / Total Shareholders’ Equity

Debt contains both short term and long term debts while Assets contains Net-worth, preference capital and Deferred Tax Liability.

(ii) Debt Asset RatioIt is the ratio of Debt to Assets which measures the extent to which borrowed funds support the firm’s assets.

Debt-asset Ratio = Debt / Assets

Debt is both short and long term while Assets here include all the assets of balance sheets.

Relation between Debt Equity ratio(X) and Debt asset ratio(Y) is Y=X/(1+X)

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3.Turnover Ratios

These measure how efficiently the assets are employed by a firm.

(a) Inventory Turnover: Also called Stock turnover it tells us how fast the inventory is moving through the firm and creating sales.

Turnover Ratio=Cost of Goods Sold/Average Inventory

This shows the efficiency of the inventory management with higher the ratio being the better management

(b) Debtors Turnover:

This  ratio shows how many times sundry debtors i.e accounts receivable turn over during the year.

Debtors Turnover = Net Credit Sales/Average sundry Debtors

Higher the debtors’ turnover the greater the efficiency of credit management.

(c) Average Collection Period

This ratio gives information on  the number of days worth of credit sales that is locked in sundry debtors.

Average Collection Period = Average sundry debtors /Average daily credit sales

Relation between b and c is  Average collection period =365/ Debtors’ turnover.

(d) Fixed Assets Turnover

This ratio measures sales per rupee of investment in fixed assets.

 Fixed Assets Turnover =Net sales /Average net fixed assets

This ratio is used  measure the efficiency with which fixed assets are employed .-A higher ratio indicates a high degree of efficiency in asset utilisation and a low ratio reflects inefficient use of assets.

When the fixed assets of the firm are old and substantially depreciated, the fixed assets turnover ratio tends to be high because the denominator of the ratio is very low.

(e) Total Assets Turnover

This is similar to  output-capital ratio in economic analysis.

Total Assets Turnover = Net sales/ Average total assets

This ratio tells us how well the assets are used.

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4. Profitability Ratios:

Profitability deals with  the final result of business operations. There are two types of profitability ratios: Profit margins ratios and Rate of return ratios.

(a) Profit Margins Ratios:  It explains the relation between Profit and Sales. As profit is measured in different levels of business operation different ratios emerge.

(i) Gross Profit Margin Ratio The gross profit margin ratio is

Gross Profit Margin Ratio = Gross profit/ Net sales

Here Gross profit is difference between net sales and cost of goods sold. It measures the efficiency of production as well as pricing

(ii) Operating Profit Margin Ratio

Operating Profit Margin Ratio= Operating profit /Net sales

This ratio tells us margin after manufacturing expenses, selling, general, and administration expenses and depreciation charges. This also reflects Operating Efficiency.

(iii) Net Profit Margin Ratio:

Net Profit Margin Ratio = Net profit/Net Sales

This ratio tells  the earnings left for shareholders as a percentage of net sales. It measures the overall efficiency of production,pricing, administration, selling, financing, and tax management.

The gross and net profit margin ratios provide an understanding of the cost and profit.

(b) Rate of Return Ratios

(i) Return on Assets

ROA = Profit after tax/ Average total assets

ROA is an odd measure because its numerator  i.e Profit after tax  measures the return to shareholders while its denominator Average total assets represents the contribution of all investors.

(ii) Earning Power

This is a measure of business performance which is not affected by interest charges and tax burden.

Earning power = Profit before interest and tax /Average total assets

The numerator represents a measure of pre-tax earnings belonging to all sources of finance and the denominator represents total financing.

(iii) Return on Capital Employed

It is also called return on invested capital (ROIC). effect of taxation is considered but not the capital structure.

 ROCE = Profit before interest and tax (1 -Tax rate) /Average total assets.

Advantage is  that it can be compared directly with the post-tax weighted average cost of capital of the firm.

(iv) Return on Equity

Return on Equity =Equity earnings/ Average equity

ROA and ROE are commonly used measures and they are accounting rates of return, hence in reality they refer to return on book assets and return on book equity.

Equity earnings is equal to profit after tax less preference dividends. Average equity includes all contributions made by equity shareholders (paid-up capital + reserves and surplus). This ratio is also called the return on net worth.

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5. Valuation Ratios:

These ratios tell us how the equity stock is assessed in the capital market. These are most comprehensive measure of performance.

(a) Yield:

Yield denotes the rate of return actually earned by equity shareholders. It is usually compared with the rate of return required by equity shareholders.

 Yield = (Dividend + Price change) /Initial price

 (b) Price-earnings Ratio

The price-earnings ratio is a summary measure which mainly reflects growth prospects, risk, shareholder orientation and the degree of liquidity.

 Price-earnings Ratio= Market price per share /Earnings per share

Market price per share is the price on a certain day or the average price over a period of time. The earnings per share = profit after tax less preference dividend / number of outstanding equity shares.

(c) Market Value to Book Value Ratio

Market Value to Book Value Ratio= Market value per share /Book value per share

It reflects the contribution of a firm to the wealth of society. When the value is more than 1 it indicates the creation of wealth is more than the invested money while less than 1 indicates detraction of the firm from the wealth of the society.

(d) Q Ratio

It was proposed by James Tobin.

Q Ratio = Market value of equity and liabilities /Estimated replacement cost of assets

The numerator of the q ratio represents the market value of equity as well as debt, not just equity, The denominator of the q ratio represents all assets at replacement cost and not book value.

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Sample Questions:

Q.1 Liquidity ratios are expressed in

a. Pure ratio form
b. Percentage
c. Rate or time
d. None of the above

Answer: (a)

Q.2. Which of the following is not included in current assets?

a. Debtors
b. Stock
c. Cash at bank
d. Cash in hand

Answer: (b)

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Q. 3. Quick ratio is 1.8:1, current ratio is 2.7:1 and current liabilities are Rs 60,000. Determine value of stock. 
a. Rs 54,000
b. Rs 60,000 
c. Rs 1,62,000
d. None of the above


Quick Ratio =Quick assets /Current liabilities

1.8 = Quick assets /Current liabilities

1.8 = Quick assets/60000

Quick assets = 60000*1.8

Current Ratio = Current Assets / Current Liabilities.

2.7= Current assets/60000

Current assets =60000*2.7

Quick Assets are current assets without inventories as inventories are least liquid in current assets.

Hence quick assets =Current assets – stock

Stock= Current assets-quick assets
Stock = 60000*2.7 – 60000*1.8

=60000*0.9= 54000

These ratios form the most important part of the syllabus of the Numericals in the phase 2 Exam and hence these need to be studied in totality and not each ratio as a separate entity. Try to find the relation between ratios as problems are often asked in combination of ratios.

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This was all from us in this blog of “Accounting Ratios – RBI Grade B Notes”. We hope that the you find the information given above in the blog of Accounting Ratios – RBI Grade B Notes useful. For more study notes for RBI Grade B, stay tuned to Oliveboard.

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