Ratio Building Blocks — Decode Any Question
Every ratio is one number divided by another. The division is never where marks are lost. Marks are lost in building the two numbers: what goes into Current Liabilities, when a bank overdraft comes out to make Quick Liabilities, what Shareholders' Funds leaves out, which profit (EBIT, EBT or NPAT) a ratio needs, and when to average. This page covers each of those building blocks first, so the formulas on the next page make sense.
Ratio analysis is Unit 7 of your syllabus, "Ratio analysis, its meaning and uses, Liquidity ratios, Leverage ratios, Profitability ratios, Activity ratios" Syllabus p. 1. It is taught in Lectures 10–12 at Bloom level ANALYSE and assessed in Term Work and the TEE CP p. 4. Both 2025-26 papers had a 10-mark ratio question (Q4) and a 5-mark ratio theory question (Q7b). All of them are solved on the Solve page and, with the rest of both papers, on Solved Papers.
How this section is organised: Building Blocks (this page) → The Formulas, family by family → Solve Anything (all 12 deck problems, all 5 practice-sheet problems, both exam questions, and a line-by-line check of your handwritten notes).
1. Where Each Number Comes From Read first
A ratio question gives you two statements. Know which one each number comes from, because that tells you whether it needs averaging.
| Balance Sheet | Profit & Loss (Income Statement) | |
|---|---|---|
| What it measures | A stock: what the business has and owes on one date (31 March) | A flow: what happened over the whole year |
| Items you take from it | Current assets, current liabilities, stock, debtors, creditors, capital, reserves, loans, fixed assets | Sales, COGS, gross profit, expenses, interest, tax, net profit, purchases |
| Ratios built only from it | Current, Quick, Debt-Equity, Proprietary | GP, NP, Operating ratio, Expense ratios, Interest Coverage |
| Ratios that mix both | ROA, ROCE, ROE, and all the turnover ratios. These are the ratios that use averages, because a year-long flow is compared with a balance that changed during the year. See §8. | |
Your practice sheet gives the P&L in the old "To … / By …" form sheet p. 1. It contains two accounts stacked on top of each other:
- Top half = Trading Account. It gives you COGS (Opening stock + Purchases + Wages − Closing stock) and Gross Profit. Every item on the left above "Gross profit c/d" is a direct cost.
- Bottom half = P&L Account. Starts with "By Gross profit b/d". The left side lists the indirect expenses (salaries, rent, selling, depreciation, interest, provision for tax). The right side lists other incomes (interest on investment). The balancing figure is Net profit.
"Net profit c/d ₹50,000" comes after "provision for tax ₹20,000", so ₹50,000 is NPAT, not NPBT. Check where tax sits before labelling a profit figure.
2. Current Assets and Current Liabilities Liquidity ratios
Current means "will turn into cash, or must be paid in cash, within one year". Apply that single test and every classification follows.
Marketable securities (short-term investments)
Debtors / Receivables / Trade receivables
Bills Receivable
Stock / Inventory (raw material, WIP, finished goods)
Prepaid expenses
Advances (to suppliers, staff)
Accrued income
NOT CA: long-term investments, fixed assets, goodwill, preliminary expenses (not a real asset at all, see §4)
Bills Payable
Outstanding expenses
Bank Overdraft / Cash Credit
Short-term loans / short-term borrowings
Provision for tax / Taxes payable
Proposed dividend (equity or preference)
Income received in advance · Unclaimed dividend
NOT CL: debentures, long-term loans, "bank loan payable after 5 years", share capital, reserves
- Provision for tax and Proposed dividend are current liabilities. Your notes say so on the Siddharth solution: "Provision for tax & Proposed Dividend are Current Liabilities" notes p. 37. They are payable within the year.
- "Bank Loans (Payable after 5 years)" is not a current liability, even though the word "bank" appears in it. It is long-term debt. The bracket is there to test exactly this. sheet Q1
- 9% Debentures ₹5,00,000 in practice sheet Q2 is a distractor. It is long-term, so it plays no part in current, liquid, stock-turnover or debtor-days calculations. sheet Q2
3. Quick Assets and Quick Liabilities The one that confuses everyone
The Acid-Test / Quick / Liquid Ratio is a stricter version of the current ratio. It asks: if the business had to pay its short-term debts right now, without selling any stock, could it? To answer that, both halves of the current ratio are trimmed. Your deck puts it in one line slide 14:
1Quick Assets: take out whatever cannot become cash quickly
| Remove from CA | Why it is not "quick" |
|---|---|
| Inventory / Stock (all kinds: raw materials, WIP, finished goods, stores, loose tools) | Stock must first be sold, and if sold on credit it then has to be collected. That is two steps and an uncertain price. In a hurry it may sell only at a heavy discount. |
| Prepaid expenses (prepaid insurance, prepaid rent) | They can never become cash. They are a right to receive a service, not money. |
| Advances paid to suppliers | Same logic as prepaid: goods or services will come back, not cash. Your notes exclude "Advance ₹2,000" in practice sheet Q2 notes p. 35. That is correct. |
What remains is Quick Assets: cash and bank balances, short-term marketable securities, debtors and bills receivable slide 14.
You can build Quick Assets in two ways, and both must give the same answer. Pick the shorter one for the question in front of you:
2Quick Liabilities: take out the Bank Overdraft
Why is the overdraft removed? A bank overdraft is technically repayable on demand, so it is a current liability. In practice it is a running credit line that the bank renews year after year (secured against stock and debtors). The business is never actually asked to repay it in one go. The quick ratio measures the genuinely urgent claims, so the overdraft comes out. The reasoning is the same on both sides: stock is removed from the top because it is slow to turn into cash, and the overdraft is removed from the bottom because it is slow to be demanded.
Scan the liabilities side of the balance sheet for any of these words: Bank OverdraftBank O/DODCash CreditCC A/c. Then:
| Case | What you see | What you do | Example |
|---|---|---|---|
| A | No overdraft anywhere in the question | QL = CL. Nothing to deduct. Write one line saying so: "No bank overdraft, hence QL = CL." This is the most common case. | Deck Q1, Q2 · Sheet Q3 (PVC) · both 2025-26 exam questions |
| B | Bank overdraft is listed | QL = CL − Bank OD. Show the subtraction. | Sheet Q1 (Siddharth: OD ₹20,000) · Sheet Q2, 2019 (OD ₹2,000) |
| C | The question itself says "Liquid assets ÷ Current liabilities", or the key you are following uses CL as the denominator | Use CL as told, and state the convention in one line. | 2025-26 Re-Exam answer key (see the warning below) |
Students see "Bank" and deduct every bank item. Only the overdraft / cash credit comes out.
- Short-term Bank Loan (Zen Ltd, deck Q2, ₹45,000 and ₹25,000) is a fixed loan with a repayment date. It stays in QL. That is why the deck's answer divides by the full ₹55,000 and ₹30,000 slide 16.
- Short-term Debt (deck Q1, $15m) stays in too. It is not described as an overdraft slide 15.
- Short-term Borrowings (Zenith Ltd, 2025-26 Final) stays in.
3Worked: Siddharth Ltd, where the overdraft is present
Balance sheet extract, practice sheet Q1 sheet p. 1:
If the denominator were CL instead: \(1{,}95{,}000 \div 1{,}08{,}000 = 1.81:1\). The overdraft makes that much difference.
Your notes get 2.21 : 1 by the same method notes p. 37. The exact figure is 2.216, which rounds to 2.22. Round, don't truncate.
Your lecture deck divides by Quick Liabilities (CL − Bank OD) slide 14. The 2025-26 Re-Exam answer key writes "Quick Ratio = (Current Assets − Inventory − Prepaid) ÷ Current Liabilities". Many textbooks also use CL.
In that exam question the two conventions gave the same answer, because there was no overdraft. They only differ when an overdraft is present (Case B). When that happens: use your deck's QL method as your main answer, and add one line: "Bank overdraft is excluded from quick liabilities as it is a quasi-permanent source of finance." That line shows the examiner you know both conventions and why the difference exists.
4. Shareholders' Funds (Equity) Leverage & returns
Your notes include a line worth memorising: "Equity, shareholder fund, net worth, owner fund, all same" notes p. 27. Add owned funds and proprietors' funds to that list. These six names all mean one number:
Deck slide 18 and slide 19; your notes p. 26.
| Include (+) | Deduct (−) — fictitious assets | Do NOT include |
|---|---|---|
| Equity share capital Preference share capital General reserve · Reserve fund Profit & Loss A/c (credit balance) Securities premium · Capital reserve Investment allowance reserve Retained profit for the year |
Preliminary expenses Discount on issue of shares/debentures Underwriting commission (unwritten-off) P&L A/c (debit balance), i.e. accumulated losses |
Debentures · long-term loans (these are debt) Proposed dividend · provision for tax (these are CL) Creditors of any kind |
Why are fictitious assets deducted? Preliminary expenses (the cost of forming the company) sit on the assets side only because they have not been written off yet. They cannot be sold and they are worth nothing. Leaving them in would overstate what the owners actually own. Deck Q3 (ABC Company) tests exactly this: SH Funds \(= 10{,}00{,}000 + 2{,}00{,}000 - 40{,}000 = ₹11{,}60{,}000\) slide 22.
- Line by line (most common): add capital + reserves, subtract fictitious assets.
- Named directly, for example "Total Equity ₹33,422": use it as given.
- Built from a profit figure: if the question gives NPAT and a proposed dividend separately, the retained part (NPAT − dividend) is added to reserves. Sheet Q4: \(200 + 150 + 50 + (56 - 10) = ₹446\) lakh notes p. 41.
5. Debt: Long-Term vs Total Leverage ratios
| Long-Term Debt (Borrowed Funds) | Also counted in Total Debt |
|---|---|
| Debentures (any %) Long-term loans / Term loans Bank loans payable after 1 year Bonds · Public deposits (long-term) Mortgage loans |
Everything on the left, plus all current liabilities: creditors, bills payable, outstanding expenses, provision for tax, bank OD, short-term loans |
Your deck's Debt-Equity ratio uses Long-Term Debt slide 18. The 2025-26 Re-Exam asked instead for "Total Debt-Equity Ratio", and its answer key counted every outside liability, current ones included. Read the exact name in the question. If it says "total", include CL. If it just says "Debt-Equity", use long-term debt only.
Deck Q3: ABC Company has trade payables of ₹4,00,000 and 12% Borrowings of only ₹40,000. The long-term debt is ₹40,000, and D/E \(= 40{,}000 \div 11{,}60{,}000 = 0.034:1\) slide 22. Trade payables are a current liability. A percentage in the name (12%, 10%, 9%) is a strong hint that the item is interest-bearing long-term debt.
6. Total Assets and Capital Employed Proprietary, ROA, ROCE
1Total Assets
Deck Q3: \(10{,}00{,}000 + 5{,}00{,}000 + (70{,}000 + 30{,}000) = ₹16{,}00{,}000\). The balance-sheet total was ₹16,40,000, and the ₹40,000 difference is the preliminary expenses notes p. 27. Your notes add that "Fixed asset is tangible assets as well as intangible assets". So goodwill, patents and trademarks count (they are real, saleable intangibles). Preliminary expenses do not.
If the question gives only the liabilities side, use the balance-sheet identity. This is how deck Q5 (AZEE Ltd) is solved, and your notes write the identity out notes p. 31:
2Capital Employed
Your notes sketch the same thing: "Sources: Shareholders' fund + Borrowed fund = TCE; Application: FA, INV, Working Capital" notes p. 31. Working capital = CA − CL. Use whichever side the question gives you more completely.
Sheet Q4: CE \(= 200 + 150 + 50 + 46 + 300 = ₹746\) lakh. That is share capital, general reserve, investment allowance reserve, retained profit, and the 15% long-term loan.
7. The Profit Ladder: Which Profit Does Each Ratio Need? Profitability & coverage
Your notebook sets this ladder out ("Sales − COGS = GP − Adm exp − S&D exp = EBITDA − D&A = EBIT − Int = EBT − Tax = EAT") just before the ratio pages, and your profitability page builds its margins from it notes p. 29. Each ratio takes its profit from a specific rung, so learn the ladder and the ratios fall into place:
| Rung | How you get there | Ratios that use this rung |
|---|---|---|
| Net Sales | Gross sales − Sales returns | Denominator of every margin and expense ratio · numerator of turnover ratios |
| − COGS | Opening stock + Purchases (net) + Direct expenses (wages, carriage inwards) − Closing stock or Sales − GP | Inventory turnover · Operating ratio |
| = Gross Profit | GP Margin | |
| − Operating expenses | Administrative + Selling & Distribution (salaries, rent, office, advertising, carriage outwards) | Expense ratios · Operating ratio |
| = EBITDA | Earnings before interest, tax, depreciation, amortisation | DSCR |
| − Depreciation & Amortisation | ||
| = EBIT (≈ Operating Profit, PBIT) | Interest Coverage · ROCE · Operating Profit Margin | |
| − Interest | Interest on debentures, loans, overdraft | |
| = EBT / NPBT / PBT | Pre-tax (NPBT) margin | |
| − Tax | Provision for tax | |
| = EAT / NPAT / PAT | The "Net Profit" of the P&L | NP Margin · ROA · ROE |
| − Preference dividend | Rate × Preference capital | |
| = Earnings for equity shareholders | EPS · Dividend payout |
1Climbing the ladder backwards
Questions often give you the bottom of the ladder (NPAT) and ask for a ratio that needs a rung higher up. Four moves cover almost every case:
2Operating vs non-operating vs financing: what counts as "operating expense"
| Item | Class | Goes into Operating ratio? |
|---|---|---|
| Salaries, rent, office & general, misc. expenses, selling, advertising, carriage outwards | Operating | Yes |
| Depreciation | Operating (cost of using the assets) | Yes. EBIT is struck after depreciation, and your deck's ICR problem deducts it too slide 23 |
| Interest paid on loans / debentures / OD | Financing | No. It is the cost of borrowing, not of operating. That is exactly why EBIT is struck before it. |
| Provision for tax | Appropriation of profit | No |
| Interest / dividend received on investments, rent received | Non-operating income | No |
| Loss on sale of investment or fixed asset | Non-operating loss | No |
This decides the Siddharth operating ratio. Your notes add interest (₹5,000) to operating expenses and get 92.78%. Leaving interest out gives 92.22%. See the full solution.
8. Averages, Credit Sales and the Other Turnover Inputs Activity ratios
If the question gives both opening and closing balances, average them. If it gives only one balance sheet, use the closing figure.
Your deck averages whenever it can (Q9 inventory, Q10 receivables, Q11 payables) slides 47–49. Your 2025-26 exam answer key used closing receivables and closing fixed assets, because each year's balance sheet was given on its own. Sheet Q2 shows both in one question: 2018 uses closing stock only (no 2017 figure exists), and 2019 averages 2018 and 2019 notes p. 36.
| Input | Build it as | If the question is silent |
|---|---|---|
| Credit sales | Gross credit sales − Sales returns (deck Q10: \(1{,}00{,}000 - 10{,}000\)) | Assume all sales are credit sales and say so. Your notes do this: "It is assumed that all sales are credit sales" p. 36 |
| Credit purchases | Credit purchases − Purchase returns (deck Q11) | Assume all purchases are credit. Your notes: "All purchase assume to be credit purchase" p. 38 |
| Debtors for turnover | Debtors + Bills Receivable (deck formula: "Average Debtors & Bills Receivable") slide 44 | Use them gross, before any provision for doubtful debts |
| Creditors for turnover | Creditors + Bills Payable slide 45 | |
| Inventory for turnover | Average of opening and closing stock (finished goods for a trader) slide 43 | Opening stock is often hiding in the Trading A/c ("To Opening stock"), not in the balance sheet |
| Fixed assets for turnover | Net of accumulated depreciation (deck Q12: \(50{,}00{,}000 - 20{,}00{,}000\)) | |
| Days in a year | 365 for days · 12 for months · 52 for weeks | Default to 365 days |
1Per-share inputs: the arithmetic behind EPS, DPS and P/E
| You need | How to get it | Example |
|---|---|---|
| Number of equity shares | Equity share capital ÷ Face value per share | Siddharth: \(1{,}50{,}000 \div 10 = 15{,}000\) shares · PVC: \(5{,}00{,}000 \div 10 = 50{,}000\) |
| Preference dividend | Rate × Preference capital. Deduct it whether or not it is "proposed", because the preference holders are paid before equity. | \(8\% \times 1{,}00{,}000 = ₹8{,}000\) |
| DPS from a percentage | "25% dividend" means 25% of FACE value, not of market price | PVC: \(25\% \times ₹10 = ₹2.50\) per share |
| Total equity dividend | DPS × Number of equity shares | \(₹2.50 \times 50{,}000 = ₹1{,}25{,}000\) |
| MPS | Given directly ("market value of equity share is ₹12") |
9. The Lookup Table: Where Does Each Item Go? Keep this open while solving
Tick = included. − = deducted. Blank = ignore for that aggregate. QL follows your deck: CL minus bank overdraft.
| Item in the question | CA | QA | CL | QL | SH Funds | LT Debt | Total Assets | Cap. Employed |
|---|---|---|---|---|---|---|---|---|
| Liabilities side | ||||||||
| Equity share capital | ✓ | ✓ | ||||||
| Preference share capital | ✓ | ✓ | ||||||
| Reserves & Surplus / General reserve / P&L (Cr) | ✓ | ✓ | ||||||
| Debentures / Long-term loans / Term loan | ✓ | ✓ | ||||||
| Bank loan payable after 1+ years | ✓ | ✓ | ||||||
| Creditors / Trade payables | ✓ | ✓ | ||||||
| Bills payable | ✓ | ✓ | ||||||
| Outstanding expenses | ✓ | ✓ | ||||||
| Provision for tax / Taxes payable | ✓ | ✓ | ||||||
| Proposed dividend | ✓ | ✓ | ||||||
| Short-term loan / Short-term bank loan | ✓ | ✓ | ||||||
| Bank overdraft / Cash credit | ✓ | ✗ | ||||||
| Assets side | ||||||||
| Fixed assets (net of depreciation), goodwill, patents | ✓ | ✓ | ||||||
| Long-term investments | ✓ | ✓ | ||||||
| Stock / Inventory | ✓ | ✗ | ✓ | ✓ via WC | ||||
| Prepaid expenses · Advances to suppliers | ✓ | ✗ | ✓ | ✓ via WC | ||||
| Debtors · Bills receivable | ✓ | ✓ | ✓ | ✓ via WC | ||||
| Cash in hand · Cash at bank | ✓ | ✓ | ✓ | ✓ via WC | ||||
| Marketable (short-term) securities | ✓ | ✓ | ✓ | ✓ via WC | ||||
| Preliminary expenses / Discount on issue / P&L (Dr) | − | ✗ | ✗ | |||||
You now know how to build every number. The Formulas, family by family → covers all 31 ratios: what each means, its standard, how to read a high or low value, and what the question must give you. Then Solve Anything → works every problem your deck, your practice sheet and your 2025-26 papers set.