Accounting Ratios Explained: Class 12 NCERT Guide for Accountancy

What Are Accounting Ratios and Why Are They Important?

Accounting Ratios are numerical relationships derived from financial statements to evaluate a business's financial health. In Class 12 NCERT Accountancy, these ratios help students understand how to assess liquidity, solvency, profitability, and operational efficiency.

Key benefits of Accounting Ratios include:

• Simplifying complex financial data
• Comparing performance over time or with other companies
• Helping investors and creditors make informed decisions

By mastering these ratios, students gain practical skills to analyse real-world business scenarios effectively.

Understanding Solvency Ratios in Class 12 NCERT

Solvency Ratios focus on a company's long-term financial stability and its ability to meet long-term debts. They are vital for creditors and investors to assess risk.

Important solvency ratios include:

1. Debt to Equity Ratio

This ratio compares total debt to shareholders' funds, showing the balance between borrowed funds and owners’ equity.

$$\text{Debt to Equity Ratio} = \frac{\text{Total Debt}}{\text{Shareholders' Funds}}$$

2. Debt to Capital Employed Ratio

It measures the proportion of debt in the total capital employed (debt + equity).

$$\text{Debt to Capital Employed} = \frac{\text{Total Debt}}{\text{Debt} + \text{Equity}}$$

3. Interest Coverage Ratio

This ratio indicates how well a company can pay interest on its debt from operating profits.

$$\text{Interest Coverage Ratio} = \frac{\text{EBIT}}{\text{Interest Expense}}$$

A lower Debt to Equity Ratio means less financial risk, while a higher Interest Coverage Ratio shows better ability to meet interest payments.

How to Calculate Debt to Equity and Interest Coverage Ratios: Worked Examples

Let's calculate these ratios using data from a sample balance sheet.

Given:

Step 1: Debt to Equity Ratio

$$\text{Debt to Equity Ratio} = \frac{6,00,000}{15,00,000} = 0.4$$

This means the company has Rs. 0.40 debt for every Rs. 1 of equity.

Step 2: Interest Coverage Ratio

$$\text{Interest Coverage Ratio} = \frac{3,00,000}{50,000} = 6$$

A ratio of 6 indicates the company earns six times its interest expense, showing strong ability to pay interest.

These calculations help students grasp practical applications of accounting ratios.

Comparing Debt Ratios: Debt to Equity vs Debt to Capital Employed

Both ratios measure the extent of debt financing but differ slightly:

Example:

If Total Debt = Rs. 6,00,000 and Shareholders’ Funds = Rs. 15,00,000:

• Debt to Equity Ratio = 0.4
• Debt to Capital Employed = $\frac{6,00,000}{6,00,000 + 15,00,000} = 0.29$

This shows debt forms 29% of the total capital employed. Understanding both helps evaluate financial leverage comprehensively.

Tips for Class 12 Students to Master Accounting Ratios from NCERT

To excel in Accounting Ratios for Class 12 NCERT Accountancy:

• Understand Formulas: Memorise key ratios and their formulas.
• Practice Calculations: Use balance sheet and profit data to compute ratios.
• Interpret Results: Learn what high or low ratios imply about financial health.
• Use Comparison Tables: Compare ratios across years or companies for better insight.
• Solve NCERT Exercises: Regularly practice NCERT problems for exam readiness.

By following these tips, students can confidently analyse financial statements and answer exam questions effectively.