Home/Study Directory/UPSC EPFO APFC
Accountancy · Beginner-friendly studyhub
Ratio Analysis for UPSC EPFO APFC:
Liquidity, Solvency, Profitability and Turnover Ratios with Worked Examples and 10 MCQs
Understand the formulas, choose the right figures, and learn what each answer means.
📤 Share this with your APFC study group
Why ratio analysis matters for APFC
A ratio compares two related numbers. If a business has ₹2 of current assets for every ₹1 of current liabilities, its current ratio is 2 : 1. Ratio analysis turns financial statements into simple questions: Can the business pay its bills? How much debt does it use? Does it earn enough profit? How efficiently does it use its resources?
For APFC practice, organise the formulas into four families: liquidity, solvency, profitability and turnover. Questions may change the inputs rather than the formula—for example, leaving prepaid expenses inside current assets or giving both opening and closing inventory. Identify the family first, then select the correct figures.
This note is conceptual accountancy. Keep the four families, one worked set and the trap list on one revision card, and you will answer most ratio stems in under a minute. For timed drills after this page, use CrackTarget’s 100-MCQ accountancy practice test and the full EPFO mock tests.
Liquidity ratios: can the firm pay short-term dues?
Liquidity ratios measure short-term solvency — the ability to meet current obligations from current resources. Three ratios appear again and again.
| Ratio | Formula | Textbook ideal (guide, not law) |
|---|---|---|
| Current ratio | Current assets ÷ Current liabilities | ~2 : 1 |
| Quick / Acid-test ratio | (CA − Inventory − Prepaid expenses) ÷ CL | ~1 : 1 |
| Cash ratio | (Cash + Marketable securities) ÷ CL | Depends on industry; often taught lower than quick |
Current assets typically include cash and bank, debtors / receivables, inventory / stock, prepaid expenses, short-term investments and bills receivable. Current liabilities include creditors, bills payable, outstanding expenses, short-term loans, bank overdraft and the current portion of long-term debt when the question presents it that way.
The acid-test excludes inventory because stock may not convert to cash quickly, and excludes prepaid expenses because they are not convertible into cash at all. That single exclusion is the most tested twist in APFC liquidity questions.
Solvency and leverage ratios: how much debt is too much?
Solvency ratios look beyond the next year. They ask whether the firm can survive long-term claims and interest burdens.
| Ratio | Formula (convention used here) |
|---|---|
| Debt-equity ratio | Long-term debt ÷ Shareholders’ equity (use total debt only if the stem says so) |
| Debt to total assets | Total debt ÷ Total assets |
| Interest coverage | EBIT ÷ Interest expense |
| Proprietary ratio | Shareholders’ equity ÷ Total assets |
State your debt convention clearly in the exam hall. Many Indian textbooks and past APFC-style stems treat debt-equity as long-term debt over equity. If the question gives only “total liabilities” or “total debt”, follow that wording. Interest coverage tells you how many times earnings before interest and tax can pay the interest bill; a higher multiple means more comfort for lenders.
Profitability ratios: is the business earning enough?
Profitability ratios relate profit figures to sales or to capital employed. Learn the numerator and denominator as a pair, not as isolated words.
- Gross profit ratio = Gross profit ÷ Net sales × 100
- Net profit ratio = Net profit ÷ Net sales × 100
- Operating ratio = (Cost of goods sold + Operating expenses) ÷ Net sales × 100
- Return on capital employed (ROCE) / ROI = EBIT (or operating profit) ÷ Capital employed × 100
- Return on equity (ROE) = Net profit attributable to equity ÷ Equity × 100
Operating ratio is often misremembered. It is not just COGS over sales. Operating expenses (selling, distribution, administration, excluding finance cost and tax in the usual textbook treatment) join COGS in the numerator. A lower operating ratio means better operating efficiency. GP% and NP% move together only if operating and non-operating items stay stable — examiners sometimes give a GP rise with an NP fall to test that awareness.
Turnover and activity ratios: how fast are assets moving?
Turnover ratios measure how efficiently the firm uses inventory, receivables, payables and total assets.
| Ratio | Formula |
|---|---|
| Inventory turnover | COGS ÷ Average inventory |
| Debtors / Receivables turnover | Credit sales ÷ Average debtors (use Net sales if the question is silent on credit sales) |
| Collection / Average collection period | 365 ÷ Debtors turnover (or 360 if the stem says) |
| Creditors turnover | Credit purchases ÷ Average creditors |
| Working capital turnover | Net sales ÷ Working capital (CA − CL) |
| Asset turnover | Net sales ÷ Average total assets (or closing, if given) |
Average inventory = (Opening + Closing) ÷ 2. If only closing stock is given, many questions allow you to use closing as a proxy — but prefer average when both figures exist. A higher inventory turnover usually signals faster stock movement; a longer collection period signals slower cash recovery from customers.
Worked numerical set: one mini Balance Sheet, many ratios
Use this compact set as your revision anchor. Memorise the shape of the numbers, not only the final answers.
Given: Current assets ₹4,00,000, of which Inventory ₹1,20,000, Prepaid ₹20,000, Debtors ₹1,40,000, Cash & bank ₹1,20,000. Current liabilities ₹2,00,000. Long-term debt ₹3,00,000; Equity ₹5,00,000. Sales ₹12,00,000; COGS ₹7,20,000; Gross profit ₹4,80,000; Net profit ₹1,20,000; Interest ₹40,000; EBIT ₹1,80,000. Opening inventory ₹80,000; Closing inventory ₹1,20,000; Average debtors ₹1,00,000; Credit sales ₹10,00,000.
| Ratio | Computation | Result |
|---|---|---|
| Current ratio | 4,00,000 ÷ 2,00,000 | 2 : 1 |
| Quick ratio | (4,00,000 − 1,20,000 − 20,000) ÷ 2,00,000 | 1.3 : 1 |
| Debt-equity | 3,00,000 ÷ 5,00,000 | 0.6 : 1 |
| Interest coverage | 1,80,000 ÷ 40,000 | 4.5 times |
| GP ratio | 4,80,000 ÷ 12,00,000 × 100 | 40% |
| NP ratio | 1,20,000 ÷ 12,00,000 × 100 | 10% |
| Inventory turnover | 7,20,000 ÷ ((80,000 + 1,20,000) ÷ 2) = 7,20,000 ÷ 1,00,000 | 7.2 times |
| Collection period | 365 ÷ (10,00,000 ÷ 1,00,000) = 365 ÷ 10 | ≈ 36.5 days |
Working capital here is 4,00,000 − 2,00,000 = ₹2,00,000. If asked, working capital turnover would be 12,00,000 ÷ 2,00,000 = 6 times. Cash ratio using cash & bank alone would be 1,20,000 ÷ 2,00,000 = 0.6 : 1.
High-yield traps
- Prepaid expenses are not quick assets. Always subtract prepaid along with inventory for the acid-test.
- Bank overdraft is a current liability, not a negative current asset, unless the question reclassifies it.
- Average vs closing inventory: prefer (opening + closing) ÷ 2 when both are given.
- Collection period = 365 ÷ debtors turnover (or 360 if the stem says). Do not multiply by 100.
- Operating ratio includes COGS + operating expenses, not COGS alone.
- Debt-equity convention: long-term debt ÷ equity unless the question specifies total debt.
- Ideal norms (2:1, 1:1) are textbook guides, not statutory limits. A question may ask what the ratio is, not whether it is ideal.
- Credit sales vs net sales: debtors turnover prefers credit sales; use net sales only when credit sales are not given.
Revision memory card
Liquidity: Current = CA/CL; Quick = (CA − Inv − Prepaid)/CL; Cash = (Cash + Marketable securities)/CL. Solvency: D/E = LT debt/Equity; Interest cover = EBIT/Interest; Proprietary = Equity/Total assets. Profit: GP% and NP% on net sales; Operating = (COGS + Op. exp.)/Sales. Turnover: Inv = COGS/Avg inv; Debtors = Credit sales/Avg debtors; Collection = 365/Debtors turnover; WC = CA − CL. Anchor set: Current 2:1 · Quick 1.3:1 · D/E 0.6 · Cover 4.5× · GP 40% · NP 10% · Inv 7.2× · Collection ≈ 36.5 days.
Practise under a timer: compute current, quick, debt-equity, GP%, inventory turnover and collection period from one extract in eight minutes. Speed on these six covers most APFC ratio stems.
10 practice MCQs with score analysis
Attempt all ten, then press Submit. You will see correct, wrong and unattempted counts, your percentage and explanations.
📤 Found this useful? Share it with a friend preparing for APFC
FAQ
Are the ideals 2:1 and 1:1 compulsory under any statute?
No. They are textbook benchmarks used in exam discussions. Actual comfortable levels vary by industry. Always compute the ratio the stem asks for before commenting on “ideal”.
Should prepaid expenses be included in quick assets?
No. Prepaid expenses cannot be converted into cash, so they are excluded from the quick / acid-test numerator along with inventory.
Do I use 365 or 360 days for the collection period?
Use 365 unless the question specifies 360 (or another base). Follow the stem exactly.
Where can I practise more accountancy MCQs?
Try CrackTarget’s 100-MCQ accountancy, auditing and insurance set and the EPFO mock tests.