FINANCIAL AND

ACCOUNTING

DIGITAL ASSIGNMENT-2

S.VIGNESH
19MBA0108
 1. Briefly explain the concept of Ratio Analysis.
Elaborate the classification of ratios.What do
you understand by the significance and
limitations of Ratio Analysis for an organization
? Explain with examples?

Ratio Analysis :
Ratio analysis is a quantitative method of gaining
insight into a company's liquidity, operational efficiency,
and profitability by comparing information contained in
its financial statements. Ratio analysis is a cornerstone
of fundamental analysis.
Outside analysts use several types of ratios to assess
companies, while corporate insiders rely on them less
because of their access to more detailed operational data
about a company.
When investors and analysts talk about fundamental or
quantitative analysis, they are usually referring to ratio
analysis. Ratio analysis involves evaluating the
performance and financial health of a company by using
data from the current and historical financial statements.
The data retrieved from the statements is used to
compare a company's performance over time to assess
whether the company is improving or deteriorating, to
compare a company's financial standing with the industry
average, or to compare a company to one or more other
companies operating in its sector to see how the
company stacks up.
Ratio analysis can be used to establish a trend line for
one company's results over a large number of financial
reporting periods. This can highlight company changes
that would not be evident if looking at a given ratio that
represents just one point in time.
Comparing a company to its peers or its industry
averages is another useful application for ratio analysis.
Calculating one ratio for competitors in a given industry
and comparing across the set of companies can reveal
both positive and negative information.
Since companies in the same industry typically have
similar capital structures and investment in fixed assets,
their ratios should be substantially the same. Different
ratio results could mean that one firm has a potential
issue and is underperforming the competition, but they
could also mean that a certain company is much better at
generating profits than its peers. Many analysts use ratios
to review sectors, looking for the most and least valuable
companies in the group.

KEY TAKEAWAYS
• Ratio analysis compares line-item data from a
company's financial statements to reveal insights
regarding profitability, liquidity, operational
efficiency, and solvency.
• Ratio analysis can be used to look at trends over
time for one company or to compare companies
within an industry or sector.
 • While ratios offer several types of insight, other
types of information and analysis are usually needed
to form a complete picture of a company's financial
position.

Examples of Ratio Analysis Categories

Most investors are familiar with a few key ratios,
particularly the ones that are relatively easy to calculate
and interpret. Some of these ratios include the current
ratio, return on equity (ROE), the debt-equity (D/E) ratio,
the dividend payout ratio, and the price/earnings (P/E)
ratio. While there are numerous financial ratios, they can
be categorized into six main groups based on the type of
analysis they provide.

1. Liquidity Ratios
It is a measure a company's ability to pay off its short-
term debts as they come due using the company's current
or quick assets. Liquidity ratios include the current ratio,
quick ratio, and working capital ratio.
2. Solvency Ratios
Also called financial leverage ratios,It compare a
company's debt levels with its assets, equity, and
earnings to evaluate whether a company can stay afloat
in the long-term by paying its long-term debt and interest
on the debt. Examples of solvency ratios include debt-
equity ratio, debt-assets ratio, and interest coverage ratio.
3. Profitability Ratios
These ratios show how well a company can generate
profits from its operations. Profit margin, return on
assets, return on equity, return on capital employed, and
gross margin ratio are all examples of profitability
ratios.
4. Efficiency Ratios
Also called activity ratios, efficiency ratios evaluate how
well a company uses its assets and liabilities to generate
sales and maximize profits. Key efficiency ratios are the
asset turnover ratio, inventory turnover, and days' sales
in inventory.
5. Coverage Ratios
These ratios measure a company's ability to make the
interest payments and other obligations associated with
its debts. The times and the debt-service coverage
ratio are both examples of coverage ratios.
6. Market Prospect Ratios
These are the most commonly used ratios in fundamental
analysis and include dividend yield, P/E ratio, earnings
per share, and dividend payout ratio. Investors use these
ratios to determine what they may receive in earnings
from their investments and to predict what the trend of a
stock will be in the future.
Examples of Ratio Analysis in Use
Ratio analysis can provide an early warning of potential
improvement or deterioration in a company’s financial
situation or performance. Analysts engage in extensive
number-crunching of the financial data in a company’s
quarterly financial reports for any such hints.
Successful companies generally have solid ratios in all
areas, and any hints of weakness in one area may spark a
significant sell-off of the stock. Certain ratios are closely
scrutinized because of their relevance to a certain sector,
such as inventory turnover for the retail sector and days
sales outstanding (DSOs) for technology companies.
Using any ratio in any of the categories listed above
should only be considered as a starting point. Further
analysis using additional ratios and qualitative analysis
should be incorporated to effectively analyze a
company's overall financial position.
Ratios are usually only comparable across companies in
the same sector, since an acceptable ratio in one industry
may be regarded as too high to too low in another. For
example, companies in sectors such as utilities typically
have a high debt-equity ratio which is normal for its
industry, while a similar ratio for a technology company
may be regarded as unsustainably high.

CLASSIFICATION OF RATIO ANALYSIS

Financial ratios can be classified under the following

five groups:
1) Structural

2) Liquidity

3) Profitability

4) Turnover
5) Miscellaneous.

STRUCTURAL GROUP:

The following are the ratios in structural group:

i) Funded debt to total capitalisation:
The term ‘total’ capitalisation comprises loan term debt,
capital stock and reserves and surplus. The ratio of
funded debt to total capitalisation is computed by
dividing funded debt by total capitalisation. It can also be
expressed as percentage of the funded debt to total
capitalisation. Long term loans

Total capitalisation (Share capital + Reserves and surplus

+ long term loans)

ii) Debt to equity:

Due care must be given to the; computation and
interpretation of this ratio. The definition of debt takes
two foremost. One includes the current liabilities while
the other excludes them. Hence the ratio may be
calculated under the following two methods:

Long term loans + short term credit + Total debt to

equity = Current liabilities and provisions Equity share
capital + reserves and surplus (or)
Long-term debt to equity =

Long – term debt / Equity share capital + Reserves and

surplus

iii) Net fixed assets to funded debt:

This ratio acts as a supplementary measure to determine
security for the lenders. A ratio of 2:1 would mean that
for every rupee of long-term indebtedness, there is a
book value of two rupees of net fixed assets:

Net Fixed assets funded debt

iv) Funded (long-term) debt to net working capital:

The ratio is calculated by dividing the long-term debt by
the amount of the net working capital. It helps in
examining creditors’ contribution to the liquid assets of
the firm.

Long term loans Net working capital

2. Liquidity group:
It contains current ratio and Acid test ratio.

i) Current ratio:
It is computed by dividing current assets by current
liabilities. This ratio is generally an acceptable measure
of short-term solvency as it indicates the extent to which
he claims of short term creditors are covered by assets
that are likely to be converted into cash in a period
corresponding to the maturity of the claims. Current
assets / Current liabilities and provisions + short-term
credit against inventory

ii) Acid-test ratio:

It is also termed as quick ratio. It is determined by
dividing “quick assets”, i.e., cash, marketable
investments and sundry debtors, by current liabilities.
This ratio is a bitterest of financial strength than the
current ratio as it gives no consideration to inventory
which may be very a low- moving.

3.PROFITABLE RATIO:

It has five ratio, and they are calculated as follows:

4. Turnover group:
It has four ratios, and they are calculated as follows:
5. Miscellaneous group:
It contains four ratio and they are as follows:

Limitations:
The following are the limitations of ratio analysis:
1. It is always a challenging job to find an adequate
standard. The conclusions drawn from the ratios can be
no better than the standards against which they are
compared.

2. When the two companies are of substantially different

size, age and diversified products,, comparison between
them will be more difficult.

3. A change in price level can seriously affect the

validity of comparisons of ratios computed for different
time periods and particularly in case of ratios whose
numerator and denominator are expressed in different
kinds of rupees.

4. Comparisons are also made difficult due to differences

of the terms like gross profit, operating profit, net profit
etc.

5. If companies resort to ‘window dressing’, outsiders

cannot look into the facts and affect the validity of
comparison.

6. Financial statements are based upon part performance

and part events which can only be guides to the extent
they can reasonably be considered as dues to the future.

7. Ratios do not provide a definite answer to financial

problems. There is always the question of judgment as to
what significance should be given to the figures. Thus,
one must rely upon one’s own good sense in selecting
and evaluating the ratios.

IMPORTANCE
A. Identifying financial risks of the company: Ratio
Analysis helps in identifying the financial risks. Ratios
like Leverage ratio, interest coverage ratio, DSCR ratio
etc. helps the firm understand how it is dependant on
external capital and whether they are capable of repaying
the debt using their own capital.
B. Planning and Forecasting of the firm: Analysts and
managers can find a trend and use the trend for future
forecasting and can also be used for important decision
making by external shareholders like the investors. They
can analyse whether they should invest in a project or
not.
C. Compare the performance of firms: The main use of
ratio is that the strengths and weakness of each firm can
be compared. The ratios can be also compared to the
firm’s previous ratio and will help to analyse whether the
company is rising or failing.
D. Helps in identifying the business risks of the firm:
Ratio analysis helps in analysing the business risk of the
firm. Calculating the leverages helps the firm understand
the business risk, that is how sensitive the profitability of
the company is with respect to its fixed cost deployment
as well as debt outstanding.
E. Analysis of operational efficiency of the firms:
Certain ratios can help us to analyse the degree of
efficiency of the firms. These ratios can be compared
with other peers of the same industry and will help to
analyse which firms are better managed as compared to
the others. It measures a company’s
capability to generate income by using the assets. This is
why efficiency ratios are very important, as an
improvement will lead to a growth in possibility.
F. Liquidity of the firms: Liquidity determines whether
the company can pay its short-term obligations or not.
Short-term obligations mean the short-term debts which
can be paid off within 12 months or within the operating
cycle.
G. Analysis of financial statements: Interpretation of the
financial statements and data is essential for all internal
and external stakeholders of the firm. Every stakeholder
has different interests when it comes to the result from
the financial statements.
H. Understanding the profitability of the company:
Profitability ratios help to determine how profitable a
firm is. Profitability ratios basically tells us how well a
company uses its investor’s money. Margins help to
analyse the firm’s ability to translate sales to profit.
Q. 2 What is the importance of Accounting
Computerization in the modern time? Justify the
differences between Manual Accounting and
Computerized Accounting system. What are the
packages used for Computerized Accounting?
Explain with examples.

A computerised accounting system is an accounting

information system that processes the financial
transactions and events as per Generally Accepted
Accounting Principles (GAAP) to produce reports as per
user requirements. Every accounting system, manual or
computerised, has two aspects. First, it has to work under
a set of well-defined concepts called accounting
principles. Another, that there is a user-defined
framework for maintenance of records and generation of
reports.
In computerised accounting system, the framework of
storage and processing of data is called operating
environment that consists of hardware as well as
software in which the accounting system works. The type
of accounting system used determines the operating
environment. Both hardware and software are
interdependent. The type of software determines the
structure of the hardware. Further, the selection of
hardware is dependent upon various factors such as the
number of users, level of secrecy and the nature of
various activities of functional departments in an
organisation.

Importance of Computerized Accounting:

• Labour Saving: Labour saving is the main aim of
introduction of computers in accounting. It refers to
annual savings in labour cost or increase in the
volume of work handled by the existing staff.
• Time Saving: Savings in time is another object of
computerization. Computers should be used
whenever it is important to save time. It is important
that jobs should be completed in a specified time
such as the preparation of pay rolls and statement of
accounts. Time so saved by using computers may be
used for other jobs.
• Organization: A computerized accounting system
help business to stay organised. When information
is entered into the system. it makes finding the
information easy. Employees can see any financial
information whenever it is needed.
• Accuracy: Accuracy in accounting statements and
books of accounts is the most important in business.
This can be done without any errors or mistakes
with the help of computers. It also helps to locate
the errors and frauds very easily.
• Storage: Storing information is vital to a business.
In Computerized System data can be stored quickly.
after information is entered into the system the
information is stored indefinitely. Companies
perform backups on the system regularly to avoid
losing any information.
• Minimization of Frauds: Computer is mainly
installed to minimize the chances of frauds
committed by the employees, especially in
 maintaining the books of accounts and handling
cash.
• Distribution: Computerized accounting systems
Allow companies to distribute Financial information
easily. Financial statements are printed directly
from the system and are distributed internally and
externally to those needing the information.
• Management reports: Data within the computerized
accounting system is accurate and up-to-date.
Management can request online report in real-time
and that makes management decisions more reliable
and timelier.
The other importance’s include Reliability, Up-to-date
information, Real time user interface, automated
documentation process, Scalability, Legibility,
Efficiency, Quality reports, MIS reports, Storage and
retrieval. Differences between Manual Accounting and
Computerized Accounting. The key differences are
related with differences in Speed, Accuracy, Automation,
Integration of accounting with other business processes,
Reporting, Compliance, Backup,
Data storage, security and management.

The other differences are:

1. Manual Accounting refers to the accounting method in
which physical registers for journal and ledger, vouchers
and account books are used to keep a record of the
financial transactions. On the other hand, computerized
accounting implies the method of accounting, which uses
an accounting software or package, to record the
monetary transactions, which happen to an organization.
2. In manual accounting, recording of the transaction can
be done through the book of original entry, i.e. journal
day book. Conversely, in computerized accounting, the
transactions are recorded in the form of data, in the
customised database.
3. In manual accounting, all the calculations, i.e.
addition, subtraction, etc. with respect to the transactions
are performed manually. In contrast, in computerized
accounting, there is no need to perform calculations, as
the calculations are performed by the computer
automatically.
4. In manual accounting, a person remains involved all
the time, with the accounts, to enter and update
transactions, which is tedious and time-consuming too.
As against, in computerized accounting, once the
transaction is entered, it is automatically updated in all
the accounts to which it relates and thus, the process is
comparatively faster.
5. In manual accounting method, if there occurs an error
while entering and posting the transaction in the books of
accounts, then adjustment entries can be passed, for
getting accurate results. Moreover, adjustment entries are
also made to comply with the matching principle, i.e. the
expenses of the accounting period should match the
respective revenues. On the other hand, in computerized
accounting, to comply with the matching principles
journal and vouchers are prepared, but adjustments
entries are not passed for rectification of error unless the
error is an error of principle.
6. One of the merits of computerized accounting which
manual accounting lacks is that in manual accounting
there is no way to back up all the entries and financial
statements, but in computerized accounting, the
accounting records can be saved and backed up.
7. In manual accounting, the trial balance is prepared
only when it is required, whereas, in computerized
accounting, instant trial balance is provided on a daily
basis.
8. In a manual accounting system, the financial statement
is prepared at the end of the period, i.e. financial year.
On the contrary, the financial statement is provided at the
click of a button, in the computerized accounting system.

Limitation of Computerised Accounting System:

• Cost of training,
• Staff opposition,
• Disruption,
• System failure,
• Inability to check unanticipated errors,
• Breaches of security,
• Ill-effects on health.

Packages used for Computerized Accounting:

Every Computerised Accounting System is
implemented to perform the accounting activity
(recording and storing of accounting data) and generate
reports as per the requirements of the user. From this
perspective.
The accounting packages are classified into the
following categories:
a) Ready to use,
b) Customised,
 c) Tailored.
Each of the categories offers distinctive features.
Choice of accounting software depends upon the
suitability and nature of the organisation especially in
terms of accounting needs.
A. Ready-To-Use: Ready-to-Use accounting
software is suited to organisations running small/
conventional business where the frequency or volume of
accounting transactions is very low. This is because the
cost of installation is generally low and number of users
is limited. Ready-to-use software is relatively easier to
learn and people (accountant) adaptability is very high.
This also implies that level of secrecy is relatively low
and the software is prone to data frauds. The training
needs are simple and sometimes the vendor (supplier of
software) offers the training on the software free.
However, this software offer little scope of linking to
other information systems.
B. Customised: Accounting software may be
customised to meet the special requirement of the user.
Standardised accounting software available in the market
may not suit or fulfil the user requirements. For example,
standardised accounting software may contain the sales
voucher and inventory status as separate options.
However, when the user requires that inventory status to
be updated immediately upon entry of sales voucher and
report be printed, the software needs to be customised.
Customised software is suited for large and medium
businesses and can be linked to the other information
systems. The cost of installation and maintenance is
relatively high because the high cost is to be paid to the
vendor for customisation. The customisation includes
modification and addition to the software contents,
provision for the specified number of users and their
authentication, etc. Secrecy of data and software can be
better maintained in customised software. Since the need
to train the software users is important, the training costs
are therefore high.
C. Tailored: The accounting software is generally
tailored in large business organisations with multi users
and geographically scattered locations. These software
requires specialised training to the users. The tailored
software is designed to meet the specific requirements of
the users and form an important part of the organisational
MIS. The secrecy and authenticity checks are robust in
such software and they offer high flexibility in terms of
number of users.

Difference between:
BASIS Ready to Customised Tailored
use
Nature of Small Medium and Large and
Business Business large business typical
business
Cost of Low Relatively High
installation high
and
maintenance
Level of Low Relatively Relatively
secrecy High High
Number of Limited As per Unlimited
users Specifications
Unlimited Restricted Yes Yes
Adaptability High Relatively Specific
High
Training Low Medium High
requirements

Ratio Analysis is a very important part of every

organisations which has several uses and needs to
various stakeholders of the company. Every company
can express their financial standing and the relationship
between two variables of the firm through ratio analysis.
Computerized Accounting plays a significant role in
today’s accounting standards and procedures. It promotes
cost effective measures and improves the overall
efficiency of the accounts. It also saves a lot of time and
unwanted labour actions.