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Class 12 Accountancy Chapter 10 Accounting Ratios — Formulas & Key Points
Chapter 10 Accounting Ratios is the backbone of financial statement analysis in CBSE Class 12 Accountancy. The NCERT framework divides ratios into four categories: liquidity (short-term payment ability), solvency (long-term financial stability), activity (asset utilisation efficiency), and profitability (earning performance). This formula sheet consolidates every ratio formula, ideal values, usage contexts, and common pitfalls into one quick-reference page.
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Key takeaways
- ✓Liquidity ratios measure short-term solvency: Current Ratio (2:1 ideal), Quick Ratio (1:1 ideal), and Absolute Liquid Ratio assess ability to pay immediate liabilities.
- ✓Solvency ratios evaluate long-term stability: Debt-Equity Ratio (lower is safer), Proprietary Ratio (higher is better), and Total Assets to Debt Ratio reveal capital structure strength.
- ✓Activity ratios gauge operational efficiency: Inventory, Debtors, Creditors Turnover Ratios and Working Capital Turnover Ratio measure how well assets are utilised.
- ✓Profitability ratios show earning capacity: Gross Profit Ratio, Operating Ratio, Net Profit Ratio, Return on Investment and Operating Profit Ratio assess profit margins and returns.
- ✓Always express turnover ratios as 'times' and profitability/liquidity ratios as pure ratios or percentages; confusion here costs marks.
- ✓Cost of Revenue from Operations = Opening Stock + Purchases + Direct Expenses − Closing Stock; Revenue from Operations excludes non-operating income.
- ✓CBSETUTOR.ai offers 24×7 AI-powered doubt solving for Class 12 Accountancy with photo-upload support at ₹999/month (all classes 6–12) — 3-day free trial available.
Liquidity Ratios — Formulas & Ideal Values
Liquidity ratios measure a firm's capacity to meet short-term obligations. The three key ratios are Current Ratio, Quick (Acid-Test) Ratio, and Absolute Liquid Ratio. Current assets include cash, bank, debtors, bills receivable, stock, and marketable securities. Current liabilities comprise creditors, bills payable, outstanding expenses, short-term loans, and bank overdraft. Quick assets exclude stock and prepaid expenses because they cannot be converted to cash immediately. Liquid assets are the most liquid subset — only cash, bank, and marketable securities. A Current Ratio of 2:1 and Quick Ratio of 1:1 are considered healthy benchmarks in most industries, though service firms may operate comfortably below these levels.
- Current Ratio = Current Assets ÷ Current Liabilities (Ideal: 2:1)
- Quick Ratio = Quick Assets ÷ Current Liabilities = (Current Assets − Stock − Prepaid Expenses) ÷ Current Liabilities (Ideal: 1:1)
- Absolute Liquid Ratio = Absolute Liquid Assets ÷ Current Liabilities = (Cash + Bank + Marketable Securities) ÷ Current Liabilities (Ideal: 0.5:1 to 1:1)
Solvency Ratios — Long-term Financial Stability Formulas
Solvency ratios assess a firm's ability to sustain operations in the long run by examining the relationship between owned funds (equity + reserves) and borrowed funds (long-term loans, debentures). Debt-Equity Ratio shows the proportion of external liabilities to shareholders' funds; a lower ratio implies less financial risk. Proprietary Ratio measures the stake of owners in total assets; higher is safer. Total Assets to Debt Ratio indicates asset coverage for every rupee of debt. Interest Coverage Ratio (or Debt Service Coverage) evaluates how comfortably the firm can pay interest out of operating profit. For CBSE board exams, remember that 'Total Assets' means both fixed and current assets, and 'Shareholders' Funds' = Equity Share Capital + Preference Share Capital + Reserves & Surplus − Fictitious Assets.
- Debt-Equity Ratio = Long-term Debts ÷ Shareholders' Funds (Lower is better; <1 is safe)
- Proprietary Ratio = Shareholders' Funds ÷ Total Assets (Higher is better; ≥0.5 is good)
- Total Assets to Debt Ratio = Total Assets ÷ Long-term Debts (Higher coverage is safer)
- Interest Coverage Ratio = Net Profit before Interest & Tax ÷ Interest on Long-term Debts (Higher multiples mean easier debt servicing)
Activity (Turnover) Ratios — Asset Utilisation Efficiency
Activity ratios measure how efficiently a business uses its assets. They are always expressed in 'times' per year. Inventory Turnover Ratio shows how many times stock is sold and replaced; higher turnover indicates fast-moving stock. Trade Receivables (Debtors) Turnover Ratio reveals how quickly credit sales are collected. Trade Payables (Creditors) Turnover Ratio measures payment speed to suppliers. Working Capital Turnover Ratio assesses sales generated per rupee of working capital. Average values are computed as (Opening + Closing) ÷ 2. Cost of Revenue from Operations (also called Cost of Goods Sold) = Opening Stock + Net Purchases + Direct Expenses − Closing Stock. Revenue from Operations = Net Sales excluding non-operating income. When only credit purchases or credit sales are given, use those; when not specified, assume all are credit.
- Inventory (Stock) Turnover Ratio = Cost of Revenue from Operations ÷ Average Inventory (times)
- Trade Receivables Turnover Ratio = Net Credit Revenue from Operations ÷ Average Trade Receivables (times)
- Trade Payables Turnover Ratio = Net Credit Purchases ÷ Average Trade Payables (times)
- Working Capital Turnover Ratio = Revenue from Operations (Net Sales) ÷ Working Capital, where Working Capital = Current Assets − Current Liabilities (times)
Profitability Ratios — Earning Capacity Indicators
Profitability ratios evaluate how well a firm generates profit relative to sales or capital employed. Gross Profit Ratio measures margin after direct costs. Operating Ratio shows operating expenses as a percentage of sales; lower is better. Net Profit Ratio reflects final profit after all expenses and taxes. Operating Profit Ratio excludes non-operating income and expenses to assess core business profitability. Return on Investment (ROI) gauges profit earned on total capital employed. All profitability ratios except ROI can be expressed as percentages by multiplying by 100. Remember: Gross Profit = Revenue from Operations − Cost of Revenue from Operations. Operating Profit = Net Profit + Non-operating Expenses − Non-operating Income. Net Profit is taken after tax unless specified otherwise. For ROI, Capital Employed can be calculated as Non-current Assets + Working Capital or Shareholders' Funds + Long-term Debts.
- Gross Profit Ratio = (Gross Profit ÷ Revenue from Operations) × 100 (%)
- Operating Ratio = [(Cost of Revenue from Operations + Operating Expenses) ÷ Revenue from Operations] × 100 (%) — Lower is better
- Operating Profit Ratio = (Operating Profit ÷ Revenue from Operations) × 100 (%) = 100 − Operating Ratio
- Net Profit Ratio = (Net Profit ÷ Revenue from Operations) × 100 (%)
- Return on Investment (ROI) = (Net Profit before Interest & Tax ÷ Capital Employed) × 100 (%)
Key Definitions & Terminology from NCERT
Understanding precise terminology is critical for CBSE Class 12 Accountancy board exams. 'Revenue from Operations' replaces the old term 'Sales' and excludes non-operating income like interest received or profit on sale of fixed assets. 'Cost of Revenue from Operations' is the new term for 'Cost of Goods Sold'. 'Trade Receivables' encompasses both Debtors and Bills Receivable. 'Trade Payables' includes Creditors and Bills Payable. 'Shareholders' Funds' = Equity Share Capital + Preference Share Capital + Reserves & Surplus (including Securities Premium, General Reserve, Profit & Loss Account credit balance) − Accumulated Losses − Fictitious Assets (Preliminary Expenses, Discount on Issue of Shares/Debentures). 'Long-term Debts' comprise Debentures, Long-term Loans, and Bonds. 'Operating Expenses' = Selling & Distribution Expenses + Administrative Expenses. 'Non-operating Income' includes Rent Received, Dividend Received, Interest on Investments, Commission Received, Profit on Sale of Fixed Assets.
- Revenue from Operations = Net Sales (excluding non-operating income)
- Cost of Revenue from Operations = Opening Stock + Net Purchases + Direct Expenses − Closing Stock
- Shareholders' Funds = Share Capital + Reserves & Surplus − Fictitious Assets
- Working Capital = Current Assets − Current Liabilities
- Capital Employed = Non-current Assets + Working Capital OR Shareholders' Funds + Long-term Debts
Memory Tricks & Mnemonics for Ratio Categories
Remembering four ratio categories and their members is easier with mnemonics. Use 'LSAP' — Liquidity, Solvency, Activity, Profitability. For Liquidity think 'CAQ': Current, Acid-test (Quick), Absolute. For Solvency think 'DEPTH': Debt-Equity, Proprietary, Total assets to debt, Interest coverage (H for 'how many times'). For Activity ratios remember 'I-DRiW': Inventory, Debtors (Receivables), Creditors (Payables — reversed order), Working capital. For Profitability use 'GRONOR': Gross, Operating, Net, Operating profit, ROI. Another tip: all turnover ratios are in 'times', all profitability ratios are percentages, and liquidity/solvency ratios are pure ratios (x:1). Writing units correctly in the board exam answer earns you method marks even if calculation has minor errors.
- LSAP: Liquidity, Solvency, Activity, Profitability
- CAQ for Liquidity: Current, Acid-test (Quick), Absolute
- DEPTH for Solvency: Debt-Equity, Proprietary, Total assets, Interest coverage
- I-DRiW for Activity: Inventory, Debtors, Creditors, Working capital turnover
- GRONOR for Profitability: Gross, Operating, Net, Operating profit, ROI
Common Mistakes — Units, Signs & Calculation Pitfalls
Students lose 1–2 marks per question by writing incorrect units or mixing formulae. Always write turnover ratios as 'times' (e.g. 6 times), never as a ratio or percentage. Express Current Ratio, Quick Ratio, Debt-Equity Ratio as x:1 (e.g. 2:1, not just 2). Profitability and some solvency ratios should be percentages when the question says 'calculate the ratio in percentage'. Never add non-operating income to Revenue from Operations; it inflates gross profit wrongly. When computing Cost of Revenue from Operations, include only direct expenses (carriage inwards, wages, factory overheads), not office salaries or selling expenses. For Interest Coverage Ratio, numerator is Net Profit before Interest AND Tax — add both back if they have been deducted. Another frequent error: using Closing Stock instead of Average Stock for Inventory Turnover; unless specified otherwise, always take average. Mixing up Trade Receivables (Debtors + Bills Receivable) with only Debtors can reduce your Debtors Turnover Ratio wrongly.
- Turnover ratios → 'times' (e.g. 5 times), NOT percentage or ratio
- Liquidity & Solvency ratios → x:1 format (e.g. 1.5:1) or percentage if asked
- Profitability ratios → percentage (multiply by 100 and add %)
- Cost of Revenue from Operations → Opening Stock + Purchases + Direct Expenses − Closing Stock (exclude indirect expenses)
- Interest Coverage numerator → NPBIT (add back both Interest and Tax to Net Profit)
- Always use Average values for stock, debtors, creditors unless stated otherwise
Solved Example 1 — Liquidity & Solvency (4 Marks)
Question: From the following information, calculate Current Ratio, Quick Ratio, Debt-Equity Ratio, and Proprietary Ratio. Current Assets ₹6,00,000 (including Stock ₹2,50,000 and Prepaid Expenses ₹30,000); Current Liabilities ₹3,00,000; Shareholders' Funds ₹10,00,000; Long-term Debts ₹5,00,000; Total Assets ₹18,00,000. Solution: Current Ratio = Current Assets ÷ Current Liabilities = 6,00,000 ÷ 3,00,000 = 2:1. Quick Assets = Current Assets − Stock − Prepaid = 6,00,000 − 2,50,000 − 30,000 = 3,20,000. Quick Ratio = 3,20,000 ÷ 3,00,000 = 1.07:1. Debt-Equity Ratio = Long-term Debts ÷ Shareholders' Funds = 5,00,000 ÷ 10,00,000 = 0.5:1. Proprietary Ratio = Shareholders' Funds ÷ Total Assets = 10,00,000 ÷ 18,00,000 = 0.56:1 or 56% (if asked as percentage).
Solved Example 2 — Activity Ratios (4 Marks)
Question: Calculate Inventory Turnover Ratio and Trade Receivables Turnover Ratio from the following. Cost of Revenue from Operations ₹18,00,000; Opening Stock ₹2,00,000; Closing Stock ₹3,00,000; Net Credit Sales ₹24,00,000; Opening Debtors ₹4,00,000; Closing Debtors ₹6,00,000; Bills Receivable throughout the year ₹1,00,000. Solution: Average Stock = (Opening Stock + Closing Stock) ÷ 2 = (2,00,000 + 3,00,000) ÷ 2 = 2,50,000. Inventory Turnover Ratio = Cost of Revenue from Operations ÷ Average Stock = 18,00,000 ÷ 2,50,000 = 7.2 times. Trade Receivables = Debtors + Bills Receivable. Average Trade Receivables = [(4,00,000 + 1,00,000) + (6,00,000 + 1,00,000)] ÷ 2 = (5,00,000 + 7,00,000) ÷ 2 = 6,00,000. Trade Receivables Turnover Ratio = Net Credit Sales ÷ Average Trade Receivables = 24,00,000 ÷ 6,00,000 = 4 times.
Solved Example 3 — Profitability Ratios (6 Marks)
Question: From the following Profit & Loss Account, calculate Gross Profit Ratio, Operating Ratio, Net Profit Ratio, and Operating Profit Ratio. Revenue from Operations ₹30,00,000; Cost of Revenue from Operations ₹18,00,000; Operating Expenses (Admin + Selling) ₹6,00,000; Non-operating Income (Rent received) ₹50,000; Interest on Loan ₹1,00,000; Tax ₹1,50,000; Net Profit after Tax ₹3,00,000. Solution: Gross Profit = Revenue from Operations − Cost of Revenue from Operations = 30,00,000 − 18,00,000 = ₹12,00,000. Gross Profit Ratio = (12,00,000 ÷ 30,00,000) × 100 = 40%. Operating Ratio = [(Cost of Revenue from Operations + Operating Expenses) ÷ Revenue from Operations] × 100 = [(18,00,000 + 6,00,000) ÷ 30,00,000] × 100 = 80%. Operating Profit Ratio = 100 − Operating Ratio = 100 − 80 = 20% (Alternatively, Operating Profit = 12,00,000 − 6,00,000 = 6,00,000; (6,00,000 ÷ 30,00,000) × 100 = 20%). Net Profit Ratio = (Net Profit ÷ Revenue from Operations) × 100 = (3,00,000 ÷ 30,00,000) × 100 = 10%.
Last-Minute One-Glance Revision Box
Use this condensed table the night before your exam. Cover one column and recall the other. Liquidity: Current = CA ÷ CL (2:1); Quick = (CA − Stock − Prepaid) ÷ CL (1:1); Absolute = (Cash + Bank + MS) ÷ CL (0.5:1). Solvency: Debt-Equity = LTD ÷ SF (lower safer); Proprietary = SF ÷ TA (higher safer); Interest Coverage = NPBIT ÷ Interest (times). Activity (all in times): Inventory TO = COGS ÷ Avg Stock; Debtors TO = Credit Sales ÷ Avg Receivables; Creditors TO = Credit Purchases ÷ Avg Payables; WC TO = Sales ÷ WC. Profitability (all %): GP Ratio = (GP ÷ Sales) × 100; OP Ratio = (OP ÷ Sales) × 100 or 100 − Operating Ratio; NP Ratio = (NP ÷ Sales) × 100; ROI = (NPBIT ÷ CE) × 100. CBSETUTOR.ai gives you instant photo-upload doubt solving and step-by-step ratio walkthroughs for ₹999/month, covering every class from 6 to 12 with a 3-day free trial — one subscription, unlimited questions.
- Liquidity: CA ÷ CL, Quick = (CA − Stock − Prepaid) ÷ CL, Liquid = Cash+Bank+MS ÷ CL
- Solvency: D/E = LTD ÷ SF, Proprietary = SF ÷ TA, Interest Cov = NPBIT ÷ Int
- Activity: Inv TO = COGS ÷ AvgStock, Debtors TO = CrSales ÷ AvgRec, WC TO = Sales ÷ WC (times)
- Profitability: GP%, OP%, NP%, ROI% — all divide by Sales (or CE for ROI) then × 100
Frequently asked questions
What is the ideal Current Ratio for CBSE Class 12 exams?+
The ideal Current Ratio is 2:1, meaning current assets should be double current liabilities. However, anything between 1.5:1 and 2.5:1 is acceptable depending on industry. Service firms may operate at lower ratios safely.
How do I calculate Cost of Revenue from Operations?+
Cost of Revenue from Operations = Opening Stock + Net Purchases + Direct Expenses (carriage inward, wages, factory expenses) − Closing Stock. Do not include indirect expenses like office salaries or selling expenses here.
What is the difference between Quick Ratio and Absolute Liquid Ratio?+
Quick Ratio excludes stock and prepaid expenses from current assets; Absolute Liquid Ratio goes further and includes only cash, bank, and marketable securities. Quick Ratio ideal is 1:1; Absolute Liquid ideal is 0.5:1 to 1:1.
Should I express Inventory Turnover Ratio as a percentage?+
No, never. All turnover (activity) ratios are expressed in 'times' (e.g. 6 times per year). Writing them as percentages or x:1 format will lose you marks in the CBSE board exam.
How is Operating Profit different from Net Profit?+
Operating Profit excludes non-operating income (like rent received, interest on investments) and non-operating expenses (like loss on sale of assets). Operating Profit = Net Profit + Non-operating Expenses − Non-operating Income. It reflects core business performance.
What is Capital Employed in ROI formula?+
Capital Employed can be calculated two ways: (1) Non-current Assets + Working Capital, or (2) Shareholders' Funds + Long-term Debts. Both methods give the same result. ROI = (NPBIT ÷ Capital Employed) × 100.
Do I use Opening or Closing Stock for Inventory Turnover Ratio?+
Use Average Stock = (Opening Stock + Closing Stock) ÷ 2, unless the question explicitly states to use only closing or opening. NCERT and CBSE marking schemes prefer average values for all turnover ratios.
How do I remember which ratios are in percentage and which are not?+
Simple rule: All profitability ratios (Gross Profit, Net Profit, Operating Profit, ROI) are percentages. All turnover (activity) ratios are in 'times'. Liquidity and solvency ratios are pure ratios in x:1 format (or percentage if question specifies).
What is included in Trade Receivables?+
Trade Receivables = Debtors + Bills Receivable. When calculating Debtors Turnover Ratio, use average of (Opening Debtors + Opening Bills Receivable) and (Closing Debtors + Closing Bills Receivable) divided by 2.
Can CBSETUTOR.ai help me solve ratio numerical step-by-step?+
Yes, absolutely. CBSETUTOR.ai offers 24×7 AI-powered tutoring where you can upload a photo of any Class 12 Accountancy ratio problem and get a detailed step-by-step solution instantly. One flat fee of ₹999/month covers all subjects and classes 6–12, with a 3-day free trial to start.
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