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Top Accounting Interview Questions (With PDF)

Ahuja Sahil
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Finance and Accounting Interview Questions (FAQs)

We have a collection of top finance and accounting interview questions compiled with real-life experiences and research with working professionals. They are a must-read for all job seekers especially freshers and intermediate-level candidates with an experience range of 0-4 years.

These accounting questions for interviews can also act as a great refresher for someone trying to brush up on their accounting fundamentals. Additionally, we recommend that you read our new blog post on “100 Accounting Terms You Must Know for Interviews“.

Bonus eBook in PDF at the end of this article!

Our research involved over 100 aspirants who went through a technical or written interview in companies such as EY, KPMG, Deloitte, PWC, Grant Thornton, Ameriprise Financial, American Express, FIS, Fluor Corporation, Genpact, Bechtel, Citigroup, Accenture, Agilent, UHG, UBS, Bank of America, HCL, Sapient, Blackstone, HSBC, FIS, WNS, AXA XL, BT, Boston Consulting Group, Royal Bank of Scotland, Whirlpool, GE, EXL, BlackRock, etc.

 

1. What are the three Golden Rules of Accounting?

three gold bricks used for golden rules of accountingFirst things first this is the most basic yet the easiest one to be taken for granted, know this well.

In bookkeeping, three golden rules of accounting are,

Personal Account – Debit the receiver, Credit the giver

Real Account – Debit what comes in, Credit what goes out

Nominal Account – Debit all expenses & losses, Credit all incomes & gains

Understand this with examples here Three Golden Rules of Accounting with examples

Related Topic – Accounts not Closed at the End of an Accounting Period?

 

2. What are the three main types of accounts?

They are Real, Personal and Nominal but wait… if don’t want to sound artificial and stand out from the crowd then make sure you are explaining your answer in brief (one line about each is ideal)

Real – All assets in business either tangible or intangible classify as real accounts.

Personal – Accounts related to a person, entity or any legal body, etc. are called personal accounts.

Nominal – All accounts related to expenses & losses or incomes & gains fall under this category.

Related Topic – List of Direct and Indirect Expenses

 

3. Why is Depreciation not Charged on Land?

Oh! this is a classic and one that fascinates the operations manager more than often. There is no scope for leaving this one out from any list of finance and accounting interview questions.

The reason why you will never see depreciation being charged on land is that land has an infinite useful life. Without knowing how many years a fixed asset will last depreciation cannot be charged.

The formula to calculate straight-line depreciation is (Cost of Fixed Asset – Scrap Value)/Useful life and you don’t have a number to fill the denominator here.

Related Topic – Quiz on Accounting Fundamentals for Beginners (#1)

 

4.  What is Amortization?

Accounting and Finance Interview Questions and Topics - Accounting CapitalAmortization is only done for Intangible assets, unlike depreciation which is for tangible assets. Reduction in value by prorating the cost of an intangible asset over multiple accounting periods is called amortization.

Example – A small-sized technology company Unreal Corp. spends 500,000 on R&D which is expected to sustain for 5 years so it may decide to amortize this & show 1,00,000 each year for 5 years in the financial statements.

If you may wish to deep dive into the topic here is our detailed article on Amortization with an example

Related Topic – How to show Amortization in Financial Statements?

 

5.  Why is Closing Stock not Shown in Trial Balance?

Not all goods purchased in beginning & during the accounting period are sold until the end of that period, this results in a remainder balance known as closing stock.

Closing stock is a part of purchases & trial balance already includes purchases, hence if the closing stock is shown as a separate item it will double count and result in an error.

Example – Purchases for a period = 60,000, Closing Stock (remainder out of purchases) = 10,000, if both of these items are separately shown inside the trial balance the effect will double up & trial balance will error-out.

This one also stands tall among top finance and accounting interview questions asked in technical rounds by hiring managers.

Related Topic – Return Inwards in Trial Balance

 

6.  What are the three main Financial Statements?

This is another very common question asked in finance and accounting interviews, especially with entry-level roles. Three main financial statements are the Income Statement, Balance Sheet, and Cash Flow Statement.

Again, follow the i.e. to add one brief statement to each one of them, but don’t over-talk it will only make you vulnerable to more questions.

Income Statement – It presents a summarized view of revenue, income, profit, and loss of a particular accounting period.

Balance Sheet – B/S would show them as on-date assets, liabilities & capital position of a business.

Cash Flow Statement – It shows the movement of cash and cash equivalents for a business during an accounting period.

Learn more on Three Main Financial Statements, Details and their Format

Related Topic – How to show Suspense A/c in Financial Statements?

 

7.  What is Capital, type of account & where is it shown in the financial statements?

Also called net worth or owner’s equity, capital is the money brought in by the owner of the business as an investment to start the operations. Capital is a type of Personal Account which belongs to an individual or a firm (owner).

Capital is shown on the liability side of a balance sheet.

Here is our detailed article on Capital along with its Journal Entry here.

Related Topic – Is Capital an Asset or Liability?

 

8.  What are Fictitious Assets?

Keep in mind that fictitious assets are not assets; they are fake or deceptive. They are actually expenses and losses that could not be written off during the accounting period. They are written off in multiple future accounting periods.

Examples – Preliminary expenses, promotional expenses of a business, discount allowed on the issue of shares, the loss incurred on the issue of debentures, etc.

Fictitious assets are shown in the balance sheet on the asset side.

Related Topic – List of Fixed Assets & Current Assets 

 

9.  What is the Journal Entry for Goods Given in Charity?

When a business decides to give goods to charity it also needs to account for those goods in the appropriate financial statement(s), in this case, purchases are reduced with the exact cost of goods donated.

Journal entry

Journal entry for goods given in charity

Related Topic – Quiz on Journal Entries for Beginners (#4)

 

10.  What is the Journal Entry for Free Samples?

When a business wants to advertise a new product or a new line of products it may decide to distribute free samples to the customer. In this case, Purchase A/c is credited and Advertisement A/c is debited.

Journal entry

Journal entry for free samples

Related Topic – Salary Received Journal Entry

 

11.  What is Depreciation, different types of depreciation & its journal entry?

The reduction in the value of a tangible fixed asset due to normal usage, wear and tear, new technology or unfavourable market conditions is called Depreciation.

Journal entry

depreciation journal entry

Types of Depreciation

  • Straight Line Method
  • Diminishing Value Method
  • Annuity method
  • Machine hour rate method
  • Revaluation method
  • Sum-of-the-years’ digit method

Read more on Depreciation with examples along with types of depreciation

Related Topic – Provision for Depreciation Shown in Trial Balance

 

12.  What are Contingent Liabilities?

Contingent liabilities are those liabilities that may or may not be incurred by a business depending on the outcome of a future event. The existence of this kind of liability is completely dependent on the occurrence of a probable event in future.

Example – Let’s suppose that Apple files a case of a patent violation on Samsung and Samsung not only realizes that it may have to pay for violations but also estimates how much in total. In this case, Samsung will record the estimated amount in its books of accounts as a Contingent Liability.

Related Topic – How & Where to Shown Contingent Assets?

 

13.  What is the difference between Reserves and Provisions?

Difference between reserves and provisions

Related Topic – Why is Provision for Doubtful Debts Created?

 

14. What are Accruals?

Another very frequently discussed topic in the list of finance and accounting interview questions is accruals. They are expenses and revenues that have been incurred or earned but have not been recorded in the books of accounts. Adjustment entries are incorporated in the financial statements to report these at the end of an accounting period.

Accrued Expense is an expense that has been incurred, but has not been recorded in the books of accounts presently. It will require an adjustment entry in the books of accounts to reflect this in the financial statements.

Accrued Income is income that has been earned, but has not been recorded in the books of accounts presently. Similar to accrued expenses, an adjustment entry will be required in this case too.

There is some more explanation on Accruals along with a couple of examples here.

 

15. What is a Contra Account?

It is an account that is used to reduce or offset the value of an associated account. It holds the opposite sign for a particular type of account.

If an account has a debit balance (e.g for an Asset a/c), then there will be a credit balance in its contra account. The opposite is true for a liability account.

Example for contra accounts

contra account examples

Read more on Contra Account with more details and examples.

 

16. What are Drawings, what type of account is it & its journal entry?

When a proprietor withdraws cash or goods from their own business for personal use it is termed as drawings. It reduces capital invested and is a temporary account that is cleared at the end of each accounting period.

“Drawings” is a Personal Account & is shown on the liability side of a balance sheet.

Journal entry for cash withdrawn

Drawings Journal Entry for Cash Withdrawn

Journal entry for goods withdrawn

Drawings Journal Entry for goods Withdrawn

Related Topic – Balance and Type of Account of a Petty Cash Book

 

17. What is a Bank Reconciliation Statement & why is it prepared?

Almost all compilations of finance and accounting interview questions include at least one question on BRS, this topic is deemed important.

Bank Reconciliation Statement or BRS refers to a statement that is made to reconcile the bank balance shown on the bank statement or passbook with the bank balance shown in the cash book.

Both internal source(s) i.e. the cash book and external source(s) i.e. the bank statement/passbook are reconciled with each other, and then all the mismatches are identified and properly recorded.

Reasons for preparing a BRS

Reasons to Prepare Bank Reconciliation Statement

More on Bank Reconciliation Statement and reasons to prepare a BRS

 

18. What is Deferred Revenue Expenditure?

Another one among the list of commonly asked finance and accounting interview questions is Deferred Revenue Expenditure. It is an expenditure that is revenue in nature and incurred during an accounting period, but its benefits are to be derived from a number of following accounting periods.

The part of the amount which is charged to the profit and loss account in the current accounting period is reduced from the total expenditure and the rest is shown on the balance sheet as an asset.

Example – A small business spends 1,50,000 on advertising which is unusually large for them. The benefits from it are expected to be derived over 3 years so the company decides to divide the expense over 3 yearly payments of 50K. This type of expense is amortized.

Example Deferred Revenue Expenditure

Related Topic – Is Deferred Revenue a Liability?

 

19. What is the difference between Trade Discount & Cash Discount?

Difference between trade discount and cash discount

Related Topic – How to Calculate Provision for Discount on Debtors?

 

20. What is a Credit Note and Debit Note?

Be ready for this question in accounting interviews for roles related to Accounts Payable and Accounts Receivable.

Debit Note – When a buyer returns goods to the seller, he sends a debit note as an intimation to the seller of the amount and quantity being returned and requesting the return of money.

Credit Note – When a seller receives goods (returned) from the buyer, he prepares and sends a credit note as an intimation to the buyer showing that the money for the related goods is being returned in the form of a credit note.

Related Topic – Debit Note Vs Credit Note

 

21. Additional 20 Finance and Accounting Interview Questions in our eBook

Golden Book of Accounting Interviews eBook Amazon Ratings

Golden Book of Accounting and Finance Interviews Part I - 3D

Get Full Version of eBook with 40 Question & Answers

The first of our two-book series “Golden Book of Accounting and Finance Interviews – Part I” contains 20 additional finance and accounting interview questions including the ones in the above article. Our eBook is a great resource for every job seeker.

*2022-23. As this eBook requires an update every year, it is no longer a free download but comes at a very nominal price of just 99 INR. This is our researched list of accounting interview questions and answers.

>Read 11 Tips to Follow for Freshers Before an Accounting Interview

>Read Compilation Journal Entries

 

What is Revenue Expenditure?

Ahuja Sahil
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Revenue Expenditure

During the normal course of business, any expenditure incurred of which benefit is received during the same accounting period is called revenue expenditure. These expenses help a business sustain its operations and may not result in an increase in revenue.

Examples of such expenses are wages, rent, power, bad debts, depreciation, telephone, printing, cost of goods (to be sold), freight, maintenance of fixed assets, etc.

Unlike capital expenditure, these expenses are relatively small & recurring in nature. Sometimes referred to as revex these are used for meeting daily requirements of a business, therefore, they are short-term i.e. the benefit received is consumed by the business within the same accounting year.

Related Topic – What is a Control Account?

 

Revenue Expenditure in Financial Statements

It is shown on the debit side of the trading account & Income statement, the accounting treatment for both revex and capex is done differently. 

All expenses are shown on the debit side of the below Trading and Profit & Loss account are revenue in nature.

revenue expenditure in financial statements

The amount transferred to trading and P&L account should only be to an extent to which goods or services have been consumed. For example, cost of goods (to be sold) is a revenue expenditure, however, only the cost of goods actually sold in the current accounting period should be transferred to the trading account.

 

Short Quiz for Self-Evaluation

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>Read Difference Between Capital Receipts and Revenue Receipts

 

What are Different Types of Purchase Orders?

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Different Types of Purchase Orders

A purchase order (PO) is an official document generated by a buyer of goods/services as an offer for the seller. It becomes a “legal document of contract” once the seller accepts the purchase order. There are mainly 4 different types of purchase orders;

  1. Standard PO
  2. Contract PO
  3. Blanket PO
  4. Planned PO

 

Standard Purchase Order

It is the most basic and widely used among different types of purchase orders, it is created when a buyer is sure about the order details such as the item, price, delivery schedule, payment terms etc.

Example – Unreal corp. decides to buy 50,000 x 9W led bulbs from GE for a unit price of 10 each to be delivered within 60 days of the order date. In such case, Unreal corp. will raise a standard PO and send it to GE for acceptance.  

 

Contract Purchase Order

It is created for a set period of time (often for a year) the item, pricing, quantity etc. can’t be anticipated precisely. In this case, a contract purchase order can be raised by the buyer, which upon acceptance becomes a legal contract.

During the contract period, the buyer can raise a standard PO with specifications of requirements and request for goods.

Example – Unreal Corp. analyzes and concludes that it often requires led bulbs of different wattage around different times of the year, however, the requirement is irregular and can’t be anticipated. In this case Unreal corp. can raise a contract purchase order.

 

Blanket Purchase Order

It is used in cases where the item is known, but the quantity and required delivery schedules are unknown. There can be numerous delivery dates against a blanket PO, they are often used in case of large quantities with exceptional discounts.

Example – Unreal corp. decides to buy 5,00,000 x 9W led bulbs each year but they are not sure about the delivery schedule & quantity of each release. In such a situation Unreal corp. will raise a blanket purchase order.

 

Planned Purchase Order

It is used for a planned purchase anticipated for long-term where the delivery schedule is not known in advance. The dates of delivery can only be anticipated therefore only tentative dates are provided to the seller. Item, pricing and quantity are however known in advance.

Example – Unreal Corp. has evaluated that it will have a long-term need for the next 5 years to buy 25,000 x 11W led bulbs each year. Instead of raising a standard PO each time Unreal Corp. can create a planned purchase order.

The reference table is shown below with different types of purchase orders and their respective scenarios

Types or purchase orders or POs

 

Short Quiz for Self-Evaluation

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Read> What is Three-Way Matching?

 

What is Three-Way Matching?

Ahuja Sahil
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Three-Way Matching

Three-way matching is a procedure used in accounts payable to authenticate and verify the disbursal of payment to a creditor. This type of match involves matching Purchase Order (PO), Goods Receipt Note (GRN) & Invoice. Various departments work together to check things like price billed, quantity billed, quality & quantity of goods received etc.

Three-way matching is an important & common technique for firms since it mitigates credit risk by avoiding fraud invoices, underpaying, overpaying etc.

Three-Way Matching Accounting

Purchase Order (PO) – After a supplier has been finalized an official document is issued by a company to a supplier to buy specific goods or services. It usually contains the date, quantity, pricing, shipping terms, T&C etc.

Goods Receipt Note (GRN) – It is a document which is usually signed by the buyer at the time of delivery thus acting as evidence that the quantity delivered is exactly as desired by the buyer in its purchase order.

Invoice – Also known as a bill, it is a statement of all items purchased by a buyer in an order with price & quantity along with the total sum due on a particular date.

To avoid payment delays for a minor difference buyers would usually have a small currency amount set as a tolerance limit so any mismatch within the prescribed threshold is ignored and the invoice is paid after successful three-way matching.

 

Short Quiz for Self-Evaluation

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Read> Days Payable Outstanding (DPO)

 

What are Final Accounts?

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Final Accounts

As the name suggests they are the final accounts which are prepared at the last stage of an accounting cycle. Final accounts show both the financial position of a business along with the profitability, they are used by external and internal parties for various purposes.

Trading account, Profit and Loss account and Balance Sheet together are called final accounts.

 

Trading Account

This account is the first account prepared as a final account, it is prepared to ascertain gross profit or gross loss incurred during an accounting period. On the debit side i.e. the LHS of the trading account items such as opening stock, purchases, and all direct expenses are shown.

Gross Profit – If the total of credit side is greater than debit side i.e. RHS > LHS the excess is called Gross Profit. It is transferred to the credit side of Profit and Loss account.

Gross Loss – If the total of the debit side is greater than the credit side i.e. LHS > RHS the excess is called Gross Loss. It is transferred to the debit side of Profit and Loss account.

Below is a sample format of trading account

Trading account format final accounts

Related Topic – Difference between Gross Profit and Net Profit

 

Profit and Loss Account

After preparation of trading account a profit and loss account also known as an income statement is prepared to ascertain the Net Profit or Net Loss incurred by a business. It begins with Gross Profit or Gross Loss being transferred from the trading account.

On the debit side of a Profit and Loss account, all indirect expenses such as salary, rent, office and admin, marketing, stationery etc. and loss incurred by the sale of assets or fire/theft etc. are mentioned.

On the credit side of a Profit and Loss account, all indirect incomes such as interest earned, dividends received on shares, bad debts recovered, profit on the sale of assets etc. are mentioned.

Below is a sample format of profit and loss account or income statement

Profit and Loss account format final accounts

Related Topic – Difference between Trial Balance and Balance Sheet

 

Balance Sheet

Both trading account and income statement help to determine the profitability of a business whereas a balance sheet is constructed to find out the financial position of the business as on a particular date. The balance sheet consists of capital, assets, and liabilities of a business.

It is a statement and not an account, it has no debit or credit side there “To” & “By” are not used inside a balance sheet. On the LHS of a balance sheet are all liabilities including capital and RHS will be all assets, for a balance sheet liabilities will always be equal to assets.

Below is a sample format of profit and loss account or income statement

Balance sheet format final accounts

 

Short Quiz for Self-Evaluation

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>Read What is Posting?

 

What are Trade Receivables and Trade Payables?

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Trade Receivables

It is the total amount receivable to a business for sale of goods or services provided as a part of their business operations. Trade receivables consist of Debtors and Bills Receivables. Trade receivables arise due to credit sales.

They are treated as an asset to the company and can be found on the balance sheet.

Trade Receivables = Debtors + Bills Receivables

 

Example – Trade Receivables

Calculate trade receivables from the below balance sheet

Calculate trade receivable numerical

Trade Receivables = 6000 (sundry debtors) + 9000 (bills receivable)

= 15,000

Debtors are people or entities to whom goods have been sold or services have been provided on credit and payment is yet to be received for that. In addition, debtors are treated as current assets in a business.

Bills Receivable (B/R) is a bill of exchange accepted by a debtor or is received in way of an endorsement from them. The amount which is due to be received on a specific date is mentioned in the bill.

Related Topic – What is Provision for Doubtful Debts?

 

Trade Payables

It is the total amount payable by a business for goods purchased or services availed as a part of their business operations. Trade payables comprise of Creditors and Bills Payables. Trade payables arise due to credit purchases.

They are treated as a liability for the company and can be found on the balance sheet.

Trade Payables = Creditors + Bills Payables

 

Example – Trade Payables

Calculate trade payables from the below balance sheet

Calculate trade payable numerical

Trade Payables = 10,000 (sundry creditors) + 10,000 (bills payable)

= 20,000

Creditors are people or entities from whom goods have been purchased or services have been availed on credit and payment is yet to be made against that. In addition, creditors are treated as current liabilities in a business.

Bills Payable (B/P) is a bill of exchange accepted by a business the amount for which will be payable on the specific date mentioned in the bill.

 

Short Quiz for Self-Evaluation

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>Read Working Capital

 

What is the Journal Entry for Recovery of Bad Debts?

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Journal Entry for Recovery of Bad Debts

At times a debtor whose account had earlier been written off by a creditor as a bad debt may decide to make a payment. This is called “recovery of bad debts”. While posting the journal entry for bad debts recovered it is important to note that it is treated as a gain for the business & that the debtor should not be credited as in the case of sales.

While journalizing for bad debts debtor’s personal account is credited and the bad debts account is debited because bad debts written off are treated as a loss to the business and now when they are recovered it is seen as a fresh gain.

Journal entry for recovery of bad debts is as follows;

Cash A/c Debit Real A/C Dr. What comes in
 To Bad Debts Recovered A/C Credit Nominal A/C Cr. income & gains

Debit (Cash A/c) assuming the recovery was done in cash

 

Rules applied as per modern or US style of accounting 

Cash or Bank A/C Debit the increase in assets
Bad Debts Recovered A/C Credit the increase in income

 

The closing journal entry for bad debts recovered would be as follows;

Bad Debts Recovered A/C  Debit
 To Profit and Loss A/C  Credit

(Transferring bad debts recovered to the income statement)

Related Topic – Journal Entry for Credit Sales and Cash Sales

 

Journal Entry for Bad Debts Recovered
Treatment of Bad Debts Recovered in the Accounting Books

 

Bad Debts Recovered Shown Inside a Financial Statement

Income statement showing bad debts recovered

Related Topic – What is Provision for Discount on Debtors?

 

Example – Journal Entry for Recovery of Bad Debts

Unreal corp was declared insolvent last year and an amount of 70,000 was shown as bad debts in the books of ABC corp, this year Unreal corp decided to pay cash 70,000 against the same debt.

In the books of ABC Corp.

Cash A/C 70,000
 To Bad Debts Recovered A/C 70,000

(Cash received from Unreal corp previously written off as bad debt)

 

Bad Debts Recovered A/C 70,000
 To Profit & Loss A/C 70,000

(Transferring bad debts recovered to the income statement)

 

Short Quiz for Self-Evaluation

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>Read Grouping and Marshalling

 

What is the Difference Between Revenue and Profit?

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Revenue vs Profit

Revenue and Profit are terms often used interchangeably however they are different and are calculated in a different way before being shown in the books of accounts. In a nutshell, the difference between revenue and profit is that Revenue can be termed as money a business makes by selling its main goods/services whereas profit is what is left after paying all the bills.

Revenue Profit
Money earned by selling main goods and/or services to customers Net Earnings of a business left after deduction of all expenses
Revenue = Total Sales – Total Returns Profit = Total Revenue – Total Expenses
Also known as Sales, Sales Revenue, Turnover, Gross Income Also known as Bottom Line, Net Profit, Net Earnings
It is shown in Trading Account It is shown in Income Statement

 

Revenue

Also known as Sales, Sales Revenue, Turnover, Gross Income, Top Line. It is the amount of money a business earns by selling its main goods & services to its customers. All proceeds gathered only from the company’s core business operations are eligible to be part of a company’s revenue.

For example, Ford Motor Company’s core business is selling cars so whatever amount it earns over a fixed period of time from the sale of cars will be its revenue for that period. Now, if Ford Motor Company has an investment of 100 Million and earns 1 Million every year from that it will not be counted towards its direct revenue rather it is termed as “income from other sources”.

Below is a trading account showing (red highlighted) Revenue of a business. (Sales – Returns)

Sales Revenue Shown in Trading Account

 

Profit

Also known as Bottom Line, Net Profit or Net Earnings. Profit is what is left after the deduction of all expenses from revenue. Profits can be calculated at various levels e.g. Gross Profit, Net Profit etc. From a broader perspective Profit = Revenue – Expenses.

Gross Profit is the difference between total revenue earned from selling products/services and the total cost of goods/services sold. Gross Profit = Total Revenue – COGS (Cost of Goods Sold)

Below is an income statement showing (in red highlighted) profit earned by a business during a particular period

Profit Shown in Profit and Loss Account

 

 

What is Operating Cash Flow Ratio?

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Operating Cash Flow Ratio

Operating cash flow ratio also known as cash flow from operations ratio is calculated by dividing cash flow from operations by current liabilities. All cash generated from firm’s core business operations is termed as operating cash.

It is different from cash generated through investing and financing in a way that it doesn’t take into account any extra cash generated apart from a business’ core operations. This ratio determines a firm’s liquidity by evaluating its operating cash with respect to its current liabilities.

Inside a cash flow statement, non-cash charges are adjusted from a business’ net income which then increases or decreases the working capital. This adjustment results in the final operating cash flow of a company.

 

Formula to Calculate Operating Cash Flow Ratio

Operating Cash Flow Ratio

Cash Flow From Operations: Revenue from operations + Non-cash based expenses – Non-cash based revenue

Current Liabilities: It includes Creditors, B/P, Accrued Expenses, Provisions, Short-Term Loans etc.

 

Example of Operating Cash Flow Ratio

From the below details of Unreal corporation calculate their operating cash flow ratio for the quarter ending 30th June 2018

  Net Cash Flow From Operations Current Liabilities
Q2 2018 200,000 150,000
Operating Cash Flow Ratio Q2 2018 1.33  

 

Cash flow from operations ratio of 1.33 shows that for every unit of current liability the company had 1.33 units of cash flow from operations during the second quarter of 2018.

 

High & Low Operating Cash Flow Ratio

High cash flow from operations ratio indicates better liquidity position of the firm. There is no standard guideline for operating cash flow ratio, it is always good to cover 100% of firm’s current liabilities with cash generated from operations. So a ratio of 1 & above is within the desirable range.

Low cash flow from operations ratio i.e. below 1 indicates that firm’s current liabilities are not covered by the cash generated from its operations. This is not a desirable state for a business and shows a stressed liquidity position.

 

Short Quiz for Self-Evaluation

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>Read What is Super Quick Ratio?

 

Sukanya Samriddhi Yojana – Details and More..

Ahuja Sahil
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Sukanya Samriddhi Yojana – Details and More..

Sukanya Samriddhi Yojana


SSY Account Girl ChildSukanya Samriddhi Yojana (SSY) is a scheme exclusively for girl children, started by the Prime Minister of India Mr. Narendra Modi on 22nd January 2015 in Panipat, Haryana. The scheme mainly assists parents of a girl child to create a reserve for their education & marriage-related expenses. 

SSY scheme proposes a deposit plan for a girl child which offers a high-interest rate on deposits. Till October 2015 under Sukanya Samriddhi Yojana there were more than 7 Million active accounts with a total fund of about US $420 Million. 

 

Benefits of Sukanya Samriddhi Yojana

  • SSY account matures after 21 years from its inception date & the amount is disbursed to the account holder. An exception to this can be availed if the girl child is above 18 years old and intends to marry.

Sukanya Samriddhi Account Maturity Amounts

  • From the year 2016-17, the rate of interest provided in this scheme is 8.6% (P.A) compounded annually. Click Here for latest Interest Rates of SSY.
  • Now 100% withdrawal is allowed from the scheme when the account holder has attained the age of 18 years.
  • Investment in Sukanya Samriddhi Yojana scheme is exempted from Income Tax under section 80(c). Principal, interest and outflow all three are exempted from tax.
  • An SSY account can be transferred to another bank/post office on request.

 

Eligibility & Other Criteria

  • The account can be opened by a guardian in the name of a girl child from her birth until she becomes 10 years old.
  • Only one account is allowed per girl child.
  • The maximum number of accounts allowed are 2 by a legal guardian for two different girl child, only exceptions provided are in case if the first or the second birth are twins or triplets.
  • A minimum of *Rs 250 needs to be deposited in the Sukanya Samriddhi Account in a financial year else it is discontinued and can only be revived with a penalty of Rs 50 per year with the minimum amount required for a deposit for that year.
  • Investment in an SSY account can be increased in multiples of thousands with a cap of Rs 1,50,000 in a financial year, a regular investment is to be made for 15 years (earlier it was 14 yrs).
  • Sukanya Samriddhi Yojna account can be opened for an adopted girl child as well.
  • Loan facility is not provided against this scheme.

 

How to Open an SSY Account & Documents Required

  • Sukanya Samriddhi Yojana account can be opened at any Indian Post office or at a branch of an authorized bank for e.g. SBI, ICICI Bank etc.
  • SSY Account Opening Form
  • Identity proof
  • Residence proof
  • Birth Certificate of the girl child

 

*Amount reduced from Rs 1000 to Rs 250.

 

Atal Pension Yojna – Details and More..

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Atal Pension Yojna – Details and More..

Atal Pension Yojna – Securing the Unorganized Sector

Atal Pension Yojna

On 9th of May 2015, Prime Minister Narendra Modi formally launched the Atal Pension Yojna (APY) which is a government supported pension program in India and is meant for workforce in the unorganized section. The scheme is managed by PFRDA (Pension Fund Regulatory and Development Authority) with the help of National Payment Scheme’s design.

Under this scheme, for every contribution made towards the pension fund, 50% of the total contribution or Rs 1000/- whichever amount is lower, will be co-funded for up to 5 years by the central government.

Government’s co-contribution is only available for those who are not covered by any statutory social security schemes and are not Income Tax payers. Pension starts once the person becomes 60 years old hence the requirement is for a person to pay for at least 20 years under the scheme.

 

Eligibility

  • APY is available to all citizens of India between 18 – 40 years of age
  • KYC compliant Bank account is a mandate

 

How to Enroll for Atal Pension Yojna

  • Walk-in to your nearest bank (All PSUs would offer this scheme)
  • You may either download the application form beforehand from a bank’s website or ask for one at the branch
  • Fill the form appropriately, ensure to mention a working mobile number & submit the form at the branch
  • Lastly you will be asked to submit a photocopy of your aadhar card along with form

All existing Swavalamban scheme subscribers, if eligible, may automatically be migrated to Atal Pension Yojna with an option to opt out.

or

Alternatively, you can download the form directly from govt. website.

 

Payout and Contribution

Under Atal Pension Yojna (APY), there is a guaranteed minimum monthly pension for subscribers, it varies between Rs 1000 and Rs 5000 per month depending upon the contribution.

Below is a chart showing different contributions at different life stages, such as if you’re 25 years old and you wish to earn a pension of Rs 5000 at the age of 60 your monthly contribution will be Rs 376 per month.

atal pension yojna payout and contribution table

The contributions are debited automatically from the subscriber’s bank account. Under APY, the monthly pension is available to the subscriber, and after their death to the spouse. In case the spouse also dies the pension corpus as accumulated at age 60 (of the subscriber) would be provided to the nominee.

 

Defaults and Discontinuation of Payments

Banks are authorized to collect a penalty amount for delayed payments, such amount will vary from Re 1 per month to Rs 10 per month depending on the contribution amount.

  • Re. 1 per month for contributions up to Rs. 100 per month
  • Re. 2 per month for contributions up to Rs. 101 – 500 per month
  • Re 5 per month for contribution between Rs 501 – 1000 per month
  • Rs 10 per month for contributions beyond Rs 1001 per month

 

If you discontinue making payments this is what happens to your account:

 After 6 Months  Account is Frozen
 After 12 Months  Account is Deactivated
 After 24 Months  Account is Closed

 

All amendments & further details can be found on the official website for this scheme www.jansuraksha.gov.in

 

 

What is a Contra Liability?

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Contra Liability

A liability account would usually contain credit balance however at times to offset a liability a separate account is used which contains debit balance and is paired along with it, this account is called a contra liability account. Seldom used in practice a contra liability account is used for book value adjustments related to an asset or a liability.

When an entry is recorded in this account the usual rules of entry are reversed adding a debit entry to the contra account. If there is no offset required against a related liability a contra account might have zero balance. Journal entry item related to contra liability account can possibly be identified with the often used word “discount”.

 

Examples of Contra Liability Account

Bond Discount Account

Journal entry for a bond worth 5000 being sold at 4800 (200 discount) would be captured as: 

contra liability journal entry example

In the above journal entry “Discount on bonds payable account” offsets the “Bonds payable account”, this can be identified since both of them are oppositely treated i.e. debited and credited respectively.

To find out the current actual value of bonds payable the accountant would have to reduce the debit balance inside the contra liability account from credit balance of the particular liability account.

Value of Bonds = Credit Balance of Bonds Payable – Debit Balance of Discount on Bonds Payable

 

Gain on Reduction Account

If a borrower is having problems in paying back his loan amount, the lender would want to get whatever amount they can from the borrower for which they might mutually consider a negotiated reduced amount. 

Though it is seldom used, however, in case if the amount payable is adjusted through negotiations gain on reduction account is used to offset the remaining amount in loan payable account which ultimately reduces the total obligations of a company.

Most often in such situations the amount of loan payable is reduced directly from loan payable account & a profit is shown on the Income statement of the business.

 

>Read Types of Liabilities

 

What is an Income Statement?

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Income Statement or Profit and Loss Account

An income statement is also known as a profit and loss account, statement of income or statement of operations. Besides balance sheet and statement of cash flows, income statement is also among important financial statements which measures the financial performance of a company over a certain period.

After the preparation of a trading account, a profit & loss account is prepared to determine the net profit earned or net loss incurred due to the operations of a business. It is an important final account of a business which shows the summarized view of revenues and expenses for a particular accounting period.

An income statement shows the profitability of a company for a specified time interval as mentioned in the heading. It may be a fiscal quarter, fiscal year or a custom range as per requirement.

Income Statement Template Sample Format

Income statement displays expenses, losses, revenue and gains. Cash transactions are never included in an income statement whether they are cash receipts or cash disbursements. It helps to determine a company’s current position whether it is in profit or loss. It is important for a company to disclose their income statement especially to those who are associated with the company e.g. investors, lenders, company management, labor unions, government agencies, potential investors etc. A profit-making company therefore not only increases its credibility in the market but also attracts more investors.

 

Profit and Loss Account or Income Statement will have the following constituents:

Revenues and Gains

  • Operating revenues derived from primary activities of a business, it may differ according to the nature of business. For a manufacturer his primary activities would be production and sale of his products but for a wholesaler or retailer his primary activities will be buying and then selling of his merchandise.
  • Revenues or income from secondary activities – Other than its main activities a business may earn from other activities as well. For example a retailer could get his extra finances by renting a place, interest revenue, etc.
  • Gains – For example: gains from lawsuits or gains from the sale of long-term assets used in business, etc.

These are shown on the right hand side of a profit and loss statement.

 

Expenses and Losses

  • Operating expenditure incurred related to all primary activities of a business.
  • Other expenses incurred related to secondary activities.
  • Losses. For example: loss from natural disasters, costs of writing down good will or intangible assets etc.

These are shown on the left hand side of a profit and loss statement.

 

The difference of two sides of this account is either net profit or net loss, which is then transferred to the capital account.

 

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What is a Balance Sheet?

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Balance Sheet

Balance sheet is a financial statement which shows the net worth of a company at the end of a financial period. A Balance sheet portrays the financial position of a company, disclosing what it owes and owns. It is an important document that needs to be prepared and submitted regularly like when submitting taxes, applying for grants or loans, while looking for investments etc. A company’s balance sheet comprises of three parts: assets, liabilities and capital or equity.

 

Following is the formula used for calculation: Assets = Liabilities + Capital

(Also known as the accounting equation or balance sheet equation)

 

Balance Sheet Template Sample Format

 

Assets

Assets are tangible or intangible resources owned by the company that has an economic value which can be expressed and measured. From a business point of view assets include cash, inventory, investment, equipment, building, etc.

Some items that may be seen in the Assets section of a company’s Balance Sheet are:

  • Cash
  • Accounts receivable
  • Patents
  • Equipment
  • Inventory
  • Reimbursable expenses

 

Liabilities

Liability is a legal obligation to be paid by the company. Liability could be incurred due to business transactions happening in the company. In a business, liabilities could be – pending taxes, credit card bills, loans etc.

Some items that may appear in the Liabilities section of a company’s Balance Sheet are:

  • Taxes
  • Accounts payable
  • Credit cards payable
  • Long term loans
  • Current loans

 

Capital or Shareholder’s Equity

Capital is the owner’s share on the company’s assets. This share is nothing but the assets that are left after the deduction of the liabilities. In a business, equity is what you infuse in the business.

Some items that could appear in the Capital section of a company’s Balance Sheet are:

  • Owners Capital – An investment from the owner in the company and the net income earned that has been earned by the company subtracted by any withdrawals if made by the owner. An owner’s personal bank account and business bank account are two different entities.
  • Retained Earnings – Part of the net income which is retained by the corporation instead of distributing it among its owners as dividends.

 

A balance sheet is perfect only when the Total Assets are exactly equal to the Sum of Liabilities and the Owner’s Equity. If there is a difference in the amounts, it needs to be rechecked for missing items.

 

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New Accounting Standards in India: A Step Up to Ind AS

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New Accounting Standards in India: A Step Up to Ind AS

Ind AS – New Accounting Rules for Companies

As per the new Accounting Standards in India (Ind AS), for companies having a net worth of Rs 500 crore or more it is mandatory to adopt the Indian Accounting Standards from April 1, 2016.

New Accounting Standards in India

In the 2009 G-20 summit, India had committed to take required steps to “restore the momentum of growth in the developing world” with the convergence of Indian Accounting Standards (Ind AS) with International Financial Reporting Standards (IFRS). After which the Ministry of Corporate Affairs devised a road map to implement the convergence of Indian Accounting Standards with International Financial Reporting Standards from April 2011.

It was meant for all Indian companies; however the insurance, banking and non-banking finance companies were exempted. The step taken was unsuccessful because of a few glitches like unresolved taxes but the FY 15 Budget had once again proposed to adopt the Ind AS. The Honorable Minister for Finance also clarified that the dates of implementation of the particular regulators for banks and insurance companies will be notified separately. A separate notification for standardized tax computation in accord with the budget will also happen on a set date.

 

The Implementation

The execution of new accounting standards in India will happen in two phases:

Phase I applicable from April 1, 2016 onwards

  • It is obligatory for all companies either listed or unlisted, having a net worth of more than Rs 500 crore to apply Ind AS.
  • It is also applicable for all the holding joint ventures, associates or subsidiaries of such companies.

Phase II applicable from April 1, 2017 onwards

  • Any company whose debt or equity securities has been listed or is going to be listed within India or outside — having a net worth of less than Rs 500 crore.
  • Unlisted companies whose net worth is more than Rs 250 Crore but less than Rs 500 crore.
  • Holding, subsidiaries, joint ventures or associates of such companies also need to apply Ind AS.

The net worth of a company has to be calculated in agreement to the company’s stand-alone financial statement as on March 31, 2014 or the audited financial statements which are first for accounting period after March 31,2014.

 

The Impact

There could be either positive or negative impact on the net income and net worth of the companies because of the areas like taxes, financial instruments and revenue recognition. Furthermore there could also be an impact on arrangements with lenders, vendors, customers, internal control systems and changes to IT system. More than 350 companies from BSE 500 are predicted to migrate from FY17. Besides delivering more disclosures application of Ind AS will also bring material changes to return ratios and operating metrics of companies.

 

 

What is RBI’s Unified Payment Interface?

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What is RBI’s Unified Payment Interface?

Unified Payment Interface (UPI) – Instant and Cashless

Developed by National Payments Corporation of India (NPCI) the Reserve Bank of India launched Unified Payment Interface (UPI). Money transfers will not only be easy to send but more instantaneous and secured.

Unified payment interface is a common system across retail systems designed to enable all account holders to both send and receive cash with the help of smartphones using Aadhar, Mobile Number etc.

The Unified Payment Interface could change the money micro-payment process throughout the country. Sending money will become as easy as sending an SMS or making a phone call. As per a report, around 65 percent in value terms and 95 percent of consumer transactions in volume terms happen in cash. For an advanced economy, transaction in volume is higher than 40 to 50 percent and 10 to 20 percent higher in terms of value.

Reserve Bank of India along with the government has been working together on techniques to diminish cash in the economy. Since the mobile industry is thriving, the number of smartphones in the country is predicted to go up from 200 million to about 500 million. There is definitely going to be a boost in mobile money transfer.

Unlike online banking which takes some time to transfer cash, UPI completes a cash transaction instantly. Presently, only some banks offer the Immediate Payment Service (IMPS); the lone way available to customers using which they can send cash across banks instantly. IMPS transaction requires details like bank account number, IFSC code, and email id for proof of identity.

UPI has eliminated manifold identifications and will accept the mobile number or Aadhar card number to complete a transaction. Phase one will have 29 banks operating the platform. It will permit instant money transfers inter-operable across many banks.

 

Unified Payment Interface

 

Key Benefits of Unified Payment Interface

  • Every consumer with a bank account can avail the benefits of this service.
  • Consumers will not require details such as account number, IFSC code etc. to transfer money.
  • Application providers can gain from integrating multiple channels, innovative features & swift authentication services.
  • Unified payment interface will lighten the burden on banks and other payment portals which deal with a huge number of mobile transactions on daily basis.

 

 

Startup India Campaign

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Startup India Campaign

Start Up India Campaign

Startup India Initiative to Boost Entrepreneurship 

On the Independence Day, 2015 at Red Fort, Prime Minister Mr.Narendra Modi recited the slogan, “Startup India, Stand up India”. Startup India campaign aims at promoting bank financing for start-up companies to encourage entrepreneurship and eventually leading to more In-house jobs for people of India. On 16 January 2016, Vigyan Bhavan, New Delhi, this campaign kick started and plans were laid out officially to ease out the hurdles hindering the path of start-ups.

 

Start Up process simplified – A mobile app was rolled out by the government on April 1, particularly for start-ups. Setting up and registering for a start-up will be abridged by this app.

Launch of Atal innovation mission – The Mission has been declared to aid incubate start-ups. The funds will be utilized to grant seed funds and will also fuel the incubation facilities that are already running. It will also train the pre-incubation entrepreneurs.

Compliance regime based on self-certification – Initially the start-ups will self-certify their compliance with the labor and environment laws. There will be no inspection for the first three years.

Protection & rebate on patents – In order to protect the patents, government will set up a panel of legal facilitators who will help in filing the patents. For the first year all the patents filed will be given a rebate of 80 percent.

Funds to be invested – For the registration process to happen smoothly the government the startups have been granted a 90 day open window to close down their businesses if they do not work out. A Rs 10,000 crore with an infusion of Rs 2,500 crore every year has been planned for the growth and expansion of the start-ups.

Tax exemption – From the 1st April, 2016 all start-ups will be relieved of both capital gain and tax in profits for the first three years. The exemption will be only for the ones who have invested in the capital gains of government recognized funds.

New Research Parks & Incubators – The government has planned to set 13 startup centers and 18 technology business centers, besides there will be 31 innovation centers to be set up at national institutions, 7 research parks, 150 technology transfer offices, 50 bio-technology incubators and 20 bio-connect offices.

Promotion of New Ideas – In order to avail these facilities, your company turn over should not exceed Rs 25 Crore. The product of the start-up business should be new and of value to the customers. This will help in new innovations rather than copying an already existing product.

For students – A Grand Challenge Program will award Rs 10 lakhs to twenty innovations done by students, starting with 5 lakh schools to target 10 lakh children for innovation program.

Easy exit policy – Convenient bankruptcy rules to be put in place which will allow a company to exit within 90 days.

 

More details on Startup India Campaign can be found at their official website www.startupindia.gov.in

 

 

What is Proprietary Ratio?

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Proprietary Ratio

This ratio shows the proportion of total assets of a company which are financed by proprietors’ funds. The proprietary ratio is also known as the equity ratio. It helps to determine the financial strength of a company & is useful for creditors to assess the ratio of shareholders’ funds employed out of the total assets of the company.

The word “Proprietors” is a synonym for “owners of a business”, proprietors’ funds, in this case, would only be the funds which belong to the owners/shareholders of the business. Proprietors’ funds are also known as Owners’ funds, Shareholders’ funds, Net Worth, etc.

 

Formula to Calculate Proprietary Ratio

Proprietary Ratio Formula

Proprietors’ funds or Shareholders’ funds = Share Capital + Reserves and Surplus

Total Assets = Includes total assets as per the balance sheet

Related Topic – Debt to Equity Ratio

 

Example of Proprietary Ratio

From the balance sheet of Unreal Corporation calculate its proprietary ratio

 Liabilities  Amt  Assets  Amt
 Share Capital  10,00,000  Tangible Assets  10,00,000
 Reserves & Surplus  2,00,000  Long-Term Investments  5,00,000
 Short-Term Borrowings  40,000  Stock  70,000
 Trade Payable  4,00,000  Trade Receivable  70,000
       
 Total  16,40,000  Total  16,40,000

Shareholders’ Funds/Total Assets

S/H Funds = 10,00,000 + 2,00,000

Total Assets = 16,40,000

12,00,000/16,40,000

Proprietary ratio = 0.73

A proprietary ratio of 0.73 shows that the company has 0.73 units of shareholders’ funds for each unit of total assets or in other words, 73% of the total assets of the company are financed by proprietors’ funds.

 

High & Low Proprietary Ratio

High – This ratio indicates the relative proportions of capital contribution by shareholders in comparison to the total assets of a company. It is used as a screening device for financial analysis, a higher ratio, say more than 75% means sufficient comfort for creditors since it points towards lesser dependence on external sources.

Low – Whereas, a lower ratio, say less than 60% means discomfort for creditors since it shows more dependence on external sources, a lower ratio can be seen as a threat and may increase the unwillingness of creditors to extend credit to the company. A company should mix and balance its external and internal sources in a way that none of them is too high in comparison to the other.

 

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What is Debt to Equity Ratio?

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Debt to Equity Ratio

Debt to equity ratio shows the relationship between a company’s total debt with its owner’s capital. It reflects the comparative claims of creditors and shareholders against the total assets of the company. It is a measurement of how much the creditors have committed to the company versus what the shareholders have committed.

Normally, the debt component includes long-term borrowings & long-term provisions, the equity component consists of net worth and preference shares not redeemable in one year.

If the purpose of calculating debt to equity ratio is to examine the financial solvency of a firm in terms of its ability to avoid financial risk, preference capital should be added to equity capital, however, if the intention is to show the effect of the use of fixed interest/dividend sources of funds w.r.t earnings available to ordinary shareholders then preference capital should be added to the debt.

 

Formula to Calculate Debt to Equity Ratio

Debt to Equity Ratio Formula

Total Debt:  Includes both long-term debt & long-term provisions

Equity (S/H Fund): Share Capital + Reserves & Surplus

 

Example of Debt to Equity Ratio

From the balance sheet of Unreal corporation calculate its debt to equity ratio

 Liabilities  Amt  Assets  Amt
 Share Capital  2,00,000  Tangible Assets  80,000
 Reserves & Surplus  40,000  Intangible Assets  1,40,000
 Long-Term Borrowings  40,000  Current Assets  1,20,000
 Long-Term Provisions  20,000
 Current Liabilities  40,000 
       
 Total  3,40,000  Total  3,40,000

 

Total Debt = Long-Term Borrowings + Long-Term Provisions

Equity (S/H Funds) = Share Capital + Reserves & Surplus

Debt/Equity = (40,000 + 20,000)/(2,00,000 + 40,000)

= 60,000/2,40,000

Debt to Equity Ratio = 0.25

A debt to equity ratio of 0.25 shows that the company has 0.25 units of long-term debt for each unit of owner’s capital.

 

High & Low Debt to Equity Ratio

This ratio indicates the relative proportions of capital contribution by creditors and shareholders. It is used as a screening device in financial analysis. A lower percentage shows that the company is less dependent on borrowed money from outside parties, or in other words, has less debt as compared to its total shareholder’s funds, this is a favourable situation for external parties since they enjoy a higher safety margin.

A higher percentage on the other hand shows that the company depends a lot on its debt (borrowed funds + money owed to others) as compared to its shareholder’s funds, this puts external parties at a higher risk. Generally, well-established companies can push their debt component to higher percentages without getting into financial trouble.

In general, felt by the lenders. One of the limitations of this ratio is that the computation is based on book value, as it is sometimes useful to calculate these ratios using market values.

 

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What is Debt to Asset Ratio?

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Debt to Asset Ratio

It is also called debt to total resources ratio or only debt ratio. The debt to asset ratio measures the percentage of total assets financed by creditors. It is computed by dividing the total debt of a company with its total assets. This ratio provides a quick look at the part of a company’s assets which is being financed with debt.

It shows the amount of debt obligation a company has for each unit of an asset that it owns, this enables the viewer to determine the financial risk of a business. This ratio measures the extent to which borrowed funds support the firm’s assets.

 

Formula to Calculate Debt to Asset Ratio

 

Formula for Debt to Asset Ratio

 

Total Debt:  Includes both long-term debt & long-term provisions. 

Total Assets: Includes both current assets and noncurrent assets.

 

Example of Debt to Asset Ratio

From the balance sheet of Unreal corporation calculate its debt to asset ratio

 Liabilities  Amt  Assets  Amt
 Share Capital  2,00,000  Tangible Assets  1,00,000
 Long-Term Borrowings  60,000  Non-current Investments  1,10,000
 Trade Payable  40,000  Current Assets  90,000
       
 Total  3,00,000  Total  3,00,000

 

Total Debt – Long-Term Borrowings

Total Asset – Tangible Assets + Non-Current Investments + Current Assets

 Total Debt/Total Assets = 60,000/3,00,000 = 0.20

A debt to asset ratio of 0.20 shows that the company has financed 20% of its total assets with outside funds, this ratio shows the extent of leverage being used by a company.

 

High & Low Debt to Asset Ratio

A lower percentage shows that the company is less dependent on borrowed money from outside parties, or in other words, has less debt as compared to its total assets, this situation is desirable from the point of view of external parties such as creditors & lenders as there is sufficient safety available to them.

A higher percentage, on the other hand, shows that the company depends a lot on its debt (borrowed funds + money owed to others) which ultimately puts external parties such as creditors & lenders to high risk. Debt to asset ratio for a business should be balanced & controlled in a way where it’s not too low but it should also not be too high.

 

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What is Acid Test Ratio?

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Acid Test Ratio

Acid Test Ratio/Liquid Ratio/Quick Ratio is a measure of a company’s immediate short-term liquidity. It is calculated by dividing liquid assets by current liabilities. Liquid assets can be termed as those assets which can almost immediately be converted to cash or an equivalent.

Unlike the current ratio, this doesn’t take into account inventories and prepaid expenses since both of them can’t be seen as liquid assets. Since the quick ratio is a better indicator of liquidity or in other words short-term solvency of a business it becomes a crucial ratio to be examined by Banks and NBFCs to check a firm’s short-term debt paying capacity.

 

Formula to Calculate Acid Test Ratio/Quick Ratio/Liquid Ratio

Formula - Acid Test Ratio or Quick Ratio or Liquid Ratio

Liquid or Quick Assets = (Total Current Assets – Inventory – Prepaid Expenses)

Acid Test Ratio = (Total Current Assets – Inventory – Prepaid Expenses)/Current Liabilities

 

Example of Acid Test Ratio

Unreal corporation has submitted the below information regarding their current assets and current liabilities, calculate the Acid Test Ratio

 Current Assets  Amt  Current Liabilities  Amt
 Cash & Equivalents  20,000  Outstanding Expenses  15,000
 Marketable Securities   150,000  Provision for Expenses  10,000
 Inventories  40,000  Creditors  20,000
 Debtors  20,000  Bills Payable  15,000
 Prepaid Expenses  10,000    
       
 Total  2,40,000  Total  60,000

 

Calculation:

(Liquid Assets or Quick Assets)/Current Liabilities

(Total Current Assets – Inventory – Prepaid Expenses)/Current Liabilities

(2,40,000 – 40,000 – 10,000)/60,000

1,90,000/60,000

3.16

 

In the above example the business has 3.16 units of liquid assets for every 1 unit of their short-term liabilities. Looking from the perspective of short-term solvency the company in this case is in a favorable condition.

Usually 1:1 is an acceptable number for acid test ratio since it shows that the business has 1 unit of quick asset for every 1 unit of short-term obligation. A lower ratio than 1:1 indicates financial difficulty for the business.

 

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What is Super Quick Ratio?

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Super Quick Ratio or Cash Ratio

This ratio goes one step ahead of current ratio, liquid ratio & is calculated by dividing super quick assets by the current liabilities of a business. It is called super quick or cash ratio because unlike other liquidity ratios it only takes into account “super quick assets”. This is the most stringent test of a business’ current liquidity situation. 

Super quick assets strictly include cash & marketable securities (since they can almost instantly be converted to cash)

Current liabilities would include overdraft, creditors, short-term loans, outstanding expenses, etc.

Formula to Calculate Super Quick or Cash ratio 

Formula super quick ratio

 

Example of Super Quick or Cash Ratio

Unreal corp. has submitted the below information regarding their current assets and current liabilities, calculate their super quick ratio.

 Current Assets  Amt  Current Liabilities  Amt
 Cash & Equivalents  20,000  Outstanding Expenses  15,000
 Marketable Securities   150,000  Provision for Expenses  10,000
 Inventories  40,000  Creditors  20,000
 Debtors  25,000  Bills Payable  15,000
 B/R  5,000    
       
 Total  2,40,000  Total  60,000

 

Calculation:

Super Quick Assets/Current Liabilities

(Cash + Marketable Securities)/Current Liabilities

= (20,000 + 150,000)/60,000

= 1,70,000/60,000

= 2.833

Higher the super quick ratio better the liquidity condition of a business. In the above case for every 1 unit of current liability, the company has 2.833 units of super quick assets, which is good.

 

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What is Ratio Analysis?

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Ratio Analysis

Ratio analysis is a process of carefully studying the relationships between different data sets inside a company’s financial statements with the help of arithmetic ratios.

It helps in a meaningful understanding of a firm’s performance and its financial position. All major financial statements can act as an input to the ratio analysis, ratios of one set of data or a combination are examined with respect to similar data or combination.

 

For example – Current Ratio, It can be computed as Current Assets/Current Liabilities

Current Assets – Can be derived from the assets side of a company’s balance sheet

Current Liabilities – Can be sought from the liability side of a company’s balance sheet

Current Assets/Current Liabilities will show the relationship between a company’s current assets and current liabilities. This ratio will help us find out the value of current assets the company holds for every unit of current liability. Accounting ratios are used to do a trend, cross-sectional & various other analysis to ascertain how the company is doing.

 

Types of Ratios

  • Liquidity Ratios – These ratios help demonstrate a company’s ability to repay its short-term financial obligations. Higher the liquidity ratio easier it is for the company to cover its short-term debts. E.g. Current Ratio, Liquid/Quick Ratio etc.
  • Solvency Ratios – These ratios show the long-term financial position of a business, it helps to measure a company’s ability to meet its long-term debt and similar obligations. E.g. Interest Coverage Ratio, Debt to Equity Ratio, Proprietary Ratio etc.
  • Profitability Ratios – As the name suggests these ratios help to determine the profitability of a firm. E.g. Gross Profit Ratio, Operating Ratio, Return on Investment, Net Profit Ratio etc.
  • Activity or Turnover Ratios – These ratios show how efficiently a company is using its resources & to identify if there is under or overutilization of resources. E.g. Debtor’s Turnover Ratio, Working Capital Turnover Ratio, Inventory Turnover Ratio etc.

Related Topic – What is Undercapitalization?

 

Types of Analysis

  • Trend Analysis – In this type of analysis ratios of business are compared with its past records to find out tendencies of growth, stagnation or decline.

Data for anyone period such as a year, month etc. are used as base and data for remaining periods is then worked around it to calculate percentage change subsequently.

Trend analysis illustration

In the above example 2 different types of trending can be seen, one with the base year 2011 & year on year trending comparing change from previous years. With base year 2011 Net profit after tax in 2012, 2013, 2014 & 2015 is 120%, 130%, 135% & 160% respectively.

With YOY trending in 2012 NPAT grew 20% with that of 2011, In 2013 in grew 8% with that of 2012 & so on. To explain we used simple numbers, similar trending can be done with ratios & shall be termed as ratio analysis.

 

  • Cross-Sectional Study – This is done by analyzing a company’s financial data with that of Industry average or Industry peers i.e. companies of similar size etc.

A comparison is done between competitors or among the industry in which the company operates for e.g. an FMCG company will be compared with the average of entire FMCG sector’s average or with that of another similarly sized competitor.

 

Short Quiz for Self-Evaluation

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>Read What is Overcapitalization?

 

What are Accounting Ratios?

Ahuja Sahil
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Accounting Ratios – Definition

Accounting ratios are mathematical expressions demonstrating a relationship between two independent or related accounting figures. Such ratios are calculated on the basis of accounting information. It is usually expressed as A:B, A to B, A/B, etc.

With the help of accounting ratios, a comparative study becomes possible, for example, if you have to prepare a 300-page book and you have a time limit of 100 days to do it, you can now analyze and evaluate (300/100 = 3/1 or 3:1) that you for every 3 pages you have 1 day.

Ratios can be expressed in any of the below formats;

Accounting ratios 4 types

 

Four Ways to Show Accounting Ratios

  • Percentage – This type of display is shown in the form of a percentage.

For example,

Current Ratio = Current Assets/Current Liabilities

Lets say, Current assets = 4,00,000 & Current liabilities = 1,00,000

Current Ratio = 4,00,000/1,00,000 = 4/1 or if seen in percentage form it is (4,00,000/1,00,000)*100 = 400%

The above example shows that at the time of calculation current assets were 400% of current liabilities.

 

  • Pure – Accounting ratios can be presented in quotient form.

For example,

Acid Test Ratio = Liquid Assets/Current Liabilities

Lets say, Liquid assets = 4,00,000 & Current liabilities = 1,00,000

Acid Test Ratio = 4,00,000/1,00,000 = 4 or it can also be shown as 4:1

 

  • Fraction – This involves expressing a ratio in the form of a fraction or proportion.

For example,

Operating Cash Flow Ratio = Cash flow from operations/Current Liabilities

Lets say, Cash flow from operations = 3,00,000 & Current liabilities = 2,00,000

Operating cash flow ratio = 3,00,000/2,00,000 = 3/2, this is the ratio in fraction form and it means for every 3 units of current assets the company has 2 units of current liabilities to be paid.

 

  • Times or Turnover Rate – Accounting ratios are also depicted in the form of ‘number of times” or “turnover rate” in comparison to another item.

For example,

Debt to Asset Ratio = Total Debt/Total Assets

Lets say, Total Debt = 3,00,000 & Total Assets = 1,00,000

Debt to Asset Ratio = 3,00,000/1,00,000 = 3 Times

It shows the relationship between Total debt and Total assets which in this case is 3 times. So, Total debt of the company is 3 times its total assets.

 

Short Quiz for Self-Evaluation

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>Read Ratio Analysis

 

What is Current Ratio?

Ahuja Sahil
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0

Current Ratio

The current ratio is a type of liquidity ratio which is established by dividing total current assets of a company with its total current liabilities. It shows the amount of current assets available with a company for every unit of current liability payable

This ratio helps to determine the short-term financial liquidity of a company which indicates how easily the company can meet its short-term financial obligations. It also aids to find out the relationship between current assets and current liabilities of a business.

 

Formula to Calculate Current Ratio

Current Ratio FormulaCurrent Assets:  It includes Cash & its equivalents, B/R, Inventory, Marketable Securities, Debtors, Loans and Advances, Prepaid Expenses, etc.

Current Liabilities: It includes Creditors, B/P, Outstanding Expenses, Provisions, Short-Term Loans etc.

 

Example of Current Ratio

From the balance sheet of Unreal corporation calculate their current ratio

 Liabilities  Amt  Assets  Amt
 Share Capital  2,00,000  Plant & Machinery  1,90,000
 Reserves & Surplus  40,000  Furniture  10,000
 Short-Term Loans  25,000  Inventories  60,000
 Trade Payable  25,000  Trade Receivable  30,000
 Expense Payable    10,000  Short-Term Investment  10,000
 Total  3,00,000  Total  3,00,000

 

Calculation:

Current Assets/Current Liabilities

Inventories + Trade Receivable + Short-Term Investment / Short-Term Loans + Trade Payable + Expense Payable 

= (60,000 + 30,000+ 10,000) / (25,000 + 25,000 + 10,000)

= 1,00,000 / 60,000

= 1.67

It shows that for every 1 unit of current liability payable the company has 1.67 units of current assets. An ideal no. for this ratio lies around 1.5 to 2.0 depending upon the kind of business.

Related Topic – What is Ratio Analysis?

High and Low Current Ratio

Higher the current ratio better the short-term strength of a company, but a deeper analysis of this ratio may also suggest problems such as poor working capital management, stock pile-up, inadequate credit management etc. anything above 2:1 could be considered as high.

On the other hand, a lower current ratio may indicate inadequate working capital & show that the company isn’t sound enough to meet its short-term financial obligations comfortably. A business with low levels may be seen as depending a lot on current liabilities. Anything below 1:1 may be considered as low.

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 20 – Current Assets

>Read What is Acid Test Ratio?

 

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