Class 12 Accountancy Important Chapter 9 Accounting Ratios

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Class 12 Accountancy Important Chapter 9 Accounting Ratios

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Accounting Ratios

Chapter: 9

Part B: Company Accounts and Analysis of Financial Statements

IMPORTANT QUESTION AND ANSWER

Answer The Following Question:

1. Why is it important for investors to analyze profitability ratios before investing in a company?

Ans: Profitability ratios help investors assess a company’s ability to generate profits relative to sales, assets, or equity. Higher profitability indicates efficient resource use and often signals better prospects for growth and return on investment.

2. How can liquidity ratios assist suppliers in making credit decisions?

Ans: Liquidity ratios, like current and quick ratios, reveal a business’s ability to pay short-term debts. Suppliers analyze these ratios to decide if extending credit is safe, thus reducing the risk of not being paid.

3. What does a very high current ratio suggest about a company’s management of working capital?

Ans: A very high current ratio may indicate that management is not utilizing its resources efficiently, as excessive funds may be tied up in current assets rather than being used for more productive investments.

4. Why are quick assets considered more reliable than total current assets in liquidity analysis?

Ans: Quick assets exclude inventories and prepaid expenses, focusing on assets that are easily and rapidly converted into cash, which gives a more accurate measure of a company’s immediate liquidity.

5. What can cause two companies in the same industry to have different debt-equity ratios?

Ans: Differences in capital structure policies, growth strategies, management attitudes toward risk, or reliance on debt versus equity financing can lead to significantly different debt-equity ratios even within the same industry.

6. How can trend analysis of profitability ratios help in forecasting future performance?

Ans: Trend analysis reviews profitability ratios over multiple periods to identify patterns, enabling analysts to predict if future earnings are likely to rise, fall, or stay stable based on past performance.

7. What role does the proprietary ratio play in assessing creditor security?

Ans: The proprietary ratio measures the proportion of assets financed by shareholders’ funds, helping creditors evaluate the security of their loans and the company’s capacity to absorb losses if needed.

8. Why might a company with high sales still have a low net profit ratio?

Ans: High sales combined with high operating costs, low margins, or substantial non-operating expenses can result in a low net profit ratio, indicating weak overall profitability despite strong revenue.

9. How does inventory turnover ratio affect a business’s liquidity?

Ans: A high inventory turnover ratio suggests inventory is sold and replaced quickly, improving liquidity by reducing capital tied up in stock and increasing available cash flow.

10. Can ratio analysis alone provide a full picture of a company’s performance?

Ans: No, ratio analysis should be used alongside qualitative assessments and other financial tools, as ratios do not reflect management quality, market conditions, or economic changes.

Fill in the Blanks:

1. Financial statements aim at providing _________ information about a business enterprise to meet the needs of decision-makers.

 Ans: Financial

2. The process of analysis, comparison, and interpretation of financial data is called _________ analysis.

 Ans: Financial statement

3. A _________ is a mathematical relationship between two or more accounting numbers.

Ans: Ratio

4. When a ratio is calculated using two unrelated numbers, it has _________ significance.

Ans: No

5. Ratio analysis helps to identify the _________ areas of the business that need more attention.

Ans: Problem