ISSUE AND

REDEMPTION
OF
DEBENTURES
 PART I
ISSUE OF
DEBENTURES
 MEANING OF DEBENTURES

▪ When Loan form public is divided into small unit of fixed amount, then
each such unit is called Debenture.

▪ Example: A Ltd want to raise loan from public for Rs. 10,00,000 which
is divided into 10,000 Debentures of Rs. 100 each.

▪ Document which is issued which acknowledge the loan taken from

public is called Debenture certificate.

▪ Debenture certificate includes Face value, rate of Interest, period of

payment, redemption value and date etc.

TYPES OF DEBENTURES

ON THE BASIS ON THE BASIS ON THE

ON THE BASIS OF
OF SECURITY OF BASIS OF
REPAYMENT
TRANSFERABILITY
AND PRIORITY CONVERSION

ON THE BASIS OF SECURITY

Naked debentures Mortgage debentures

Naked debentures are those

which do not carry any charge
on the assets of the company.
The holders of such Debentures which are secured by
debentures are not given any mortgage or charge on assets.
security as to the payment of
interest and repayment of
capital.

ON THE BASIS OF PRIORITY

FIRST DEBENTURES SECOND DEBENTURES

These debentures have

priority over other debentures These debentures are repaid after
as regard payment out of the the claims of the first
proceeds of the property debentures have been met.
mortgaged.
 ON THE BASIS OF REPAYMENT

REDEEMABLE IRREDEEMABLE

In the case of irredeemable or

perpetual debentures the
company does not give any
undertaking of repaying
debentures, after a fixed term
▪ In this case, Debenture amount is or within a fixed period during
returned to holders after a certain the continuance of business
period. by the company. Company
▪ Redemption can be at par, may repay debentures at any
premium or at discount. Time but the creditors cannot
compel the company to repay
them at any certain time.
They shall, however, be repaid
when the company goes into
liquidation or makes a default
in the payment of interest.

ON THE BASIS OF TRANSFERABILITY

REGESTERED BEARER DEBENTURES

Registered debentures are

made out in the name of a
particular person, who is
Bearer debentures are treated
registered as a debenture-
as negotiable instruments and
holder in the books of the
are transferable by delivery
company. The names of the
alone. The names of the
debenture-holder are recorded
holders of such debentures
in the company's register of
are not required to be
debentures holders They are
registered in the register of
transferable in the same way
debenture-holders.
as shares or in accordance
with the conditions endorsed
on their back.
 ON THE BASIS OF CONVERSION

CONVERTIBLE NON CONVERTIBLE

In this case, Debenture In this case, Debenture

holders have right to convert holders have No right to
Debentures into equity convert Debenture into
shares after a certain period equity shares

ISSUE OF DEBENTURES

ISSUE OF ISSUE OF ISSUE OF

DEBENTURES AT DEBENTURES AT DEBENTURES AT
PAR PREMIUM DISCOUNT

ISSUE OF DEBENTURES AT PAR

Journal Entries (Face Value of Rs. 100)

Particulars Dr. (Rs.) Cr. (Rs.)

(a) When Application money received:
Bank a/c Dr.
To Debenture Application a/c
(Being Application money received)
(b) When Debenture Allotted
Debenture Application a/c Dr.
To Debenture a/c
(Being Amount transferred)
EXAMPLE 1:
A Ltd Issued 10,000 10% Debenture of Rs. 100 payable entire amount
with application. Pass Journal Entries.

ISSUE OF DEBENTURES AT PREMIUM

Journal Entries (Face Value of Rs. 100, ISSUE PRICE 120)

Particulars Dr. (Rs.) Cr. (Rs.)

(a) When Application money received:
Bank a/c Dr.
To Debenture Application a/c
(Being Application money received)
(b) When Debenture Allotted
Debenture Application a/c Dr.
To Debenture a/c
To Securities Premium
(Being Amount transferred)
EXAMPLE 2:
A Ltd Issued 10,000 10% Debenture of Rs. 100 issued at Rs. 120 per
shares payable entire amount with application. Pass Journal Entries.

ISSUE OF DEBENTURES AT DISCOUNT

Journal Entries (Face Value of Rs. 100, Issued at Rs. 90)

Particulars Dr. (Rs.) Cr. (Rs.)

(a) When Application money received:
Bank a/c Dr.
To Debenture Application a/c
(Being Application money received)
(b) When Debenture Allotted
Debenture Application a/c Dr.
Discount on Issue of deb Dr.
To Debenture a/c
(Being Amount transferred)
EXAMPLE 3:
A Ltd Issued 10,000 10% Debenture of Rs. 100 each issued at 90%
payable entire amount with application. Pass Journal Entries.

Note:
If Question require to receive amount on issue of debentures in
installment i.e. on application, allotment, calls etc., then entries will be
made in the same way as in case of Issue of shares

When Debentures are redeemable at Premium, then we have to pass an

Additional Entry at time of issue of Debentures in which we will
recognize Premium payable on Redemption as liability along with Loss
on issue of Debentures and such entry will be:

Loss on Issue of Debenture a/c Dr.

To Premium Payable on Redemption a/c
(Being Premium payable on redemption recognized)

EXAMPLE 4:
A Ltd Issued 20,000 10% Debenture of Rs. 100 each issued at 90%
payable entire amount with application such debentures are redeemable
at 20% Premium after 5 years. Pass Journal Entries.
 HOW TO WRITE OFF DISCOUNT / LOSS ON ISSUE OF
DEBENTURES

Discount or Loss on Issue of Debentures will be written off at the end of

each year in the ratio of Amount of debenture outstanding at the end of
each year over the period of redemption.

Entry for Discount written off will be as under:

P&L a/c Dr.
To Discount/Loss on Issue of Debenture a/c

HOW TO CALACULATE RATIO FOR WRITE OFF

WHEN DEBENTURES ARE WHEN DEBENTURES ARE

REDEEMABLE AFTER A CERTAIN REDEEMABLE IN
PERIOD INSTALLMENTS

In this case, Amount used by

company will be equal in each year, In this case, Amount used by
so discount written off each year company will be different in
will also be equal each year each year, so discount written
off each year will be written
Discount w/o = off in each year in the ratio of
Total Discount Amount used.
Redemption period

EXAMPLE 5:
A Ltd Issued 20,000 10% Debenture of Rs. 100 each issued at 90% on
01-01-2020. Such Debentures are redeemable after 5 years in Lumpsum.
Calculate Discount written off each year. Accounts are closed on 31st
December each year.

EXAMPLE 6:
A Ltd Issued 50,000 10% Debenture of Rs. 100 each issued at 12%
Discount on 01-04-2018. Such Debentures are redeemable in 5 equal
installments starting from 31-03-2019. Calculate Discount written off
each year. Accounts are closed on 31st March each year.

EXAMPLE 7:
A Ltd Issued 20,000 10% Debenture of Rs. 100 each issued at 18%
Discount on 01-04-2020. Such Debentures are redeemable in 5 equal
installments starting from 31-03-2022. Calculate Discount written off
.each year. Accounts are closed on 31st March each year.
 ISSUE OF DEBENTURES AS COLLETRAL SECURITY

▪ When a company takes loan from bank or from financial institutions

and as a security for such loan, company gives its Debentures to Bank
in addition to any other security already given, it is called Issue of
Debentures as collateral security.

▪ When company repaid its loan, then such debentures will be return
back by bank to company.

ACCOUNTING FOR ISSUE OF DEBENTURES AS

COLLETRAL SECURITY
CASE 1 – NO ENTRY PASSED BY COMPANY

▪ When company not passed entry for issue of such Debentures, then
Only disclosure is given in notes to Account along with Loan stating
that such loan is secured by issue of Debentures as collateral security

CASE 2 – WHEN ENTRY IS PASSED BY COMPANY

▪ In this case, Company has passed Entry for issue of Debentures as

collateral security as under:
Debentures Suspense a/c Dr.
To Debentures a/c
(Being Debentures are issued as Collateral Security)

▪ Debentures will be shown in Non Current Liabilities in Balance sheet

▪ Debenture Suspense a/c will be shown in Asset side of Balance sheet
under Non current Assets or it may be shown as deduction from
Debentures in Non current Liabilities.

When Loan is repaid and Debentures are return back, above entry will be
reversed.
EXAMPLE 10:
A Ltd has taken a Loan of Rs. 20,00,000 from State bank of India which
is secured against Land & Building. In addition to Building, Company
Issued 20,000 Debentures of Rs. 100 each as collateral Security. What
will be Accounting Treatment for Issue of Debentures in following
Cases:

Case 1 - when No Entry is Passed

Extracts of Balance Sheet

Liabilities Notes Amounts (Rs.)

I – EQUITY AND LIABILITIES

2. Non Current Liabilities
Loan from SBI 20,00,000
Total

II – ASSETS

Total

Notes to Accounts
Non Current Liabilities
Loan from SBI (Secured against L&B) 20,00,000
(Also secured by issue of 20,000 Debentures of Rs. 100 each)

Case 2 – when Entry is Passed

Debentures Suspense a/c Dr.

To Debentures a/c
(Being 20,000 Debentures of Rs. 100 are issued as Collateral Security)

Extracts of Balance Sheet

Liabilities Notes Amounts

(Rs.)
I – EQUITY AND LIABILITIES

2. Non Current Liabilities

Loan from SBI 20,00,000
Debentures 20,00,000
Total

II – ASSETS
Non Current Assets
Other Non current Assets
Debenture Suspense a/c 20,00,000
Total
 Notes to Accounts
Non Current Liabilities
Loan from SBI (Secured against L&B) 20,00,000
(Also secured by issue of 20,000 Debentures of Rs. 100 each)
Debentures 20,00,000
(Issued as Collateral Security)

DEBENTURE INTEREST

▪ Company is Liable to pay Interest to debenture holders as per the

term & conditions.

▪ Debenture Interest is expenses for company and it is a charge against

profit.

▪ Company is liable to deduct TDS from the Interest and such TDS is
paid to Government.

ACCOUNTING FOR DEBENTURE INTEREST

When Interest Due

Debentures Interest a/c Dr.

To TDS Payable
To Debenture holders a/c
(Being Debenture Interest due)

When Amoun Paid

TDS Payable a/c Dr.

Debenture holders a/c Dr.
To Bank a/c
(Being Amount Paid)

EXAMPLE 11:
A Ltd has 10,000 15% Debentures of Rs. 100 each on 01-04-23. Interest
is payable half yearly on 30th Sep and 31st March each year. TDS is 10%.
Pass JE
 PART II
REDEMPTION
OF
DEBENTURES
 REDEMPTION OF DEBENTURES
When company repaid the amount of debentures to Debenturholders,
then it is called Redemption of Debentures.

SOURCES OF REDEMPTION

WHEN REDEMPTION IS MADE OUT WHEN REDEMPTION IS MADE

OF CAPITAL OUT OF PROFIT

In this case, Redemption is made In this case, Redemption is

out of Capital i.e. out of issue of made out of profit earned by
fresh issue of capital, existing or company either in past or in
fresh loan etc. current year.

Journal Entries when Redemption is out of Capital

▪ When Redemption Due

Debentures a/c Dr.
Redemption of Debentures a/c Dr.
To Debenture holders a/c

▪ When Amount paid

Debentures Holders a/c Dr.
To Bank a/c

Note:
When redemption is out of profit, then in addition to above two entries,
one additional entry is also passed in which an amount equal to face
value of debenture redeemed will be transferred to from profit & Loss
a/c to General Reserve.

Profit & Loss a/c Dr.

To General Reserve a/c

EXAMPLE 1
A Ltd has 10,000 15% Debentures of Rs. 100 each on 01-04-23. Now
company redeemed such debentures at 20% Premium. Pass JE in
following cases:
Case I – When Redemption is out of capital
Case II – When Redemption is out of Profit
 METHODS OF REDEMPTION

REDEMPTION BY
REDEMPTION IN CASH
CONVERSION

REDEMPTION IN REDEMPTION IN
LUMPSUM INSTALLEMENT

DRAWING BY OPEN MARKET

LOTS OPERATION

REDEMPTION IN CASH

REDEMPTION IN INSTALLEMENT

DRAWING BY LOTS OPEN MARKET OPERATION

▪ Under this case, own

debentures are purchased and
▪ This is a Lottery system
such debentures are cancelled
with existing debentures
▪ In this case, normal entries
Liabilities.
for redemptions are passed
as and when redemption is
▪ Any Gain on cancellation will
made.
be transferred to Capital
Reserve a/c
 ACCOUNTING FOR OPEN MARKET OPERATION

Journal Entries

▪ When Dentures are purchased from open market

Own Debentures a/c Dr. (Cost of Debentures)
Interest on Debentures a/c Dr. (Interest up to date of purchase)
To Bank a/c

▪ When Debentures are cancelled

Debentures a/c Dr. (Face value of debentures)
To Own Debentures a/c (Cost of Debentures)
To Capital Reserve a/c ( Profit on cancellation)

Note:
When redemption is out of profit, then in addition to above two
entries, one additional entry is also passed in which an amount
equal to face value of debenture redeemed will be transferred to
from profit & Loss a/c to General Reserve.

Profit & Loss a/c Dr.

To General Reserve a/c

QUOTATION PRICE FOR PURCHASE CAN BE

CUM- INTEREST
EX- INTEREST

In this types of price

In this types of price
quotation, Price paid for
quotation, Price paid for
Debentures are Inclusive
Debentures are exclusive
of Interest. Means
of Interest. Means
interest up to the date of
interest up to the date of
purchase are not paid
purchase are paid
separately. It is included
separately
in price quotation

Note:
if nothing specified, then we will assume price quotation is Ex-
Interest price quotation.
EXAMPLE 2
A Ltd has 12,000 15% Debentures of Rs. 100 each on 01-04-23. Now
company redeemed such debentures at par in 3 equal Annual
Installment starting from 31-03-24. Pass JEs in all 3 years.

EXAMPLE 3
A Ltd has 20,000 18% Debentures of Rs. 100 each on 01-04-23. interest
is paid on 30th Sep and 31st March every year.
company purchased following own debentures from open market for
immediate cancellation:
▪ 4,000 Debentures @ Rs. 96 Ex – Interest on 1-06-23
▪ 3,000 debentures @ Rs. 99 Cum – Interest on 31st December 23

Pass JEs

WHEN OWN DEBENTURES ARE PURCHASED FROM

OPEN MARKET BUT NOT CANCELLED IMMEDIETELY BUT
CANCELLED AT A LATER DATE

In this case, on each Interest payment date, interest on own

debenture will be recognized as saving in interest until the
debentures are cancelled.

Following entry for interest is passed in this case:

Interest on Debentures a/c Dr. (Total Interest)
To Bank a/c (Interest on debentures paid to outsiders)
To Interest on own Debentures a/c

EXAMPLE 4
A Ltd has 30,000 12% Debentures of Rs. 100 each on 01-04-23. interest
is paid on 30th Sep and 31st March every year.
company purchased following own debentures from open market:
▪ 6,000 Debentures @ Rs. 97 Ex – Interest on 1-06-23
▪ 4,000 debentures @ Rs. 99 Cum – Interest on 01-12-23
▪ 3,000 debentures @ Rs. 95 Cum – Interest on 01-02-24

All the debentures were cancelled on 31st March 2024

Pass JEs
 REDEMPTION IN LUMPSUM
SINKING FUND METHOD

▪ Under this method, The company sets aside a certain amount of

money each period (often annually) into a sinking fund. This fund is
specifically earmarked for the eventual redemption of the debentures.

▪ The money in the sinking fund is usually invested in safe and liquid
investments such as government securities or bonds, which earn
interest.

▪ When the debentures mature, instead of redeeming them directly from

the company's resources, the company uses the money accumulated
in the sinking fund (including the interest earned on investments) to
redeem the debentures.

Journal Entries under sinking fund method

1st Year – End of the year

▪ When amount set aside out of profit
P&L Dr.
To Sinking Fund a/c

(Amount set aside for each year is calculated after considering

Redemption amount, period of redemption and Interest rate on sinking
fund Investments)

▪ When Sinking fund Investments are purchased

Sinking Fund Investments a/c Dr.
To Bank
(with the amount equal to set aside out of profit)

At the end of 2nd Year & onward except Last year

▪ When Interest on Investment received
Bank a/c Dr.
To Interest on Sinking Fund Investment a/c

▪ When Interest Transferred

Interest on Sinking Fund Investment a/c Dr.
To Sinking Fund a/c
OR

▪ Direct entry can be passed for Interest

Bank a/c Dr.
To Sinking Fund a/c
(With Interest Amount)
▪ When amount set aside out of profit
P&L Dr.
To Sinking Fund a/c

▪ When Sinking fund Investments are purchased

Sinking Fund Investments a/c Dr.
To Bank
(with the amount equal to set aside out of profit + Interest rec.)

Note:
If sinking fund is non cumulative, then Interest on S.F Investments will
be transferred to P&L and not reinvested.

In the Last Year

▪ When Interest on Investment received
Bank a/c Dr.
To Sinking Fund a/c

▪ When Investments are sold

Bank a/c Dr.
To Sinking Fund Investments a/c
(With Amount of Sale Proceeds)
Note:
Any profit or loss on sale of investments will be transferred to sinking
fund a/c

▪ When Debentures are due for redemption

Debentures a/c Dr. (Face Value)
Premium on Redemption a/c Dr. (Premium Amount)
To Debenture Holders a/c

▪ When Amount paid

Debenture Holders a/c Dr.
To Bank a/c

▪ Premium on Redemption will be written off against Sinking fund

Sinking Fund a/c Dr.
To Premium on Redemption a/c

▪ After redemption, Amount equal to face value of redemption will be

transferred from sinking fund a/c to General Reserve a/c
Sinking Fund a/c Dr.
To General Reserve a/c

Note:
In Last year, Balancing figure in Sinking fund a/c will be taken as
amount set aside out of profit
EXAMPLE 5
P Ltd. issued Rs. 30,00,000, 10% debentures on January 1, 2021. These
were to be redeemed on 31st December, 2023. For this purpose, the
company established Sinking Fund. Investments were expected to earn
5% interest p.a. Sinking Fund table shows that 0.317208 invested
annually at 5% amount to Rs. 1 in 3 years. On 31st December, 2023 the
investment was sold for Rs. 1968,000. Interest received and
investments are made in multiples of Rs. 100. Prepare Accounts
 REDEMPTION BY CONVERSION

▪ When Debentures are converted into equity shares or Preference

shares or New Debentures, then it is known as Redemption by
conversion

▪ In this case number shares issued are calculated as under:

Amount payable to Debenture holders
Issue price

Journal Entries

▪ When Debentures are due for redemption

Debentures a/c Dr. (Face Value)
Premium on Redemption a/c Dr. (Premium Amount)
To Debenture Holders a/c

▪ When Shares/Debentures are Issued

Debenture Holders a/c Dr.
To Share Capital a/c
To Securities Premium a/c
To Debentures a/c
(with the amount equal to set aside out of profit)

Note:
If there is fraction in calculation of shares or Debentures, then fraction
will be paid in cash.

EXAMPLE 6
A Ltd had 12,500 Debentures of Rs. 100 which are redeemable at 10%
Premium. Holders of Debentures also given an option to convert their
debentures into equity shares of Rs 10 each at Rs. 15 per shares.
60% Debenture holders accepted the offer of conversion and rest take
cash. Pass Journal Entries.
 RATIO
ANALYSIS
 MEANING OF RATIOS ANALYSIS

It refers to the systematic use of ratios to interpret the financial

statements in terms of the operating performance and financial
position of a firm. It involves comparison for a meaningful
interpretation of the financial statements.

VAROIUS TYPES OF RATIO

Solvency or
Liquidity Turnover Profitability
Leverage
Ratio Ratio ratios
ratios

1. LIQUIDITY RATIO

▪ It measures the ability of the firm to meet its short-term obligations,

that is capacity of the firm to pay its current liabilities as and when
they fall due.

▪ These ratios reflect the short-term financial solvency of a firm.

▪ A firm should ensure that it does not suffer from lack of liquidity.

▪ The various ratios that explains about the liquidity of the firm are:
1. Current Ratio
2. Acid Test Ratio / quick ratio
3. Absolute liquid ration / cash ratio

CURRENT RATIO

▪ The current ratio measures the short-term solvency of the firm.

▪ It establishes the relationship between current assets and current
liabilities.
▪ It is calculated by dividing current assets by current liabilities as
under

Current Ratio = Current Asset

Current Liabilities
 CURRENT ASSETS AND CUURENT LIABILITIES
INCLUDES

Current assets include:

▪ Cash and bank balances
▪ Short Term Investments (Marketable securities)
▪ Inventory
▪ Debtors (excluding provisions for bad debts and doubtful debtors)
▪ Bills receivables
▪ Prepaid expenses.

Current liabilities includes

▪ Sundry creditors
▪ Bills payable,
▪ Short - term loans
▪ Income-tax liability
▪ Accrued expenses
▪ Dividends payable.

LIQUID RATIO

▪ This Ratio is also called Quick Ratio and Acid Test Ratio

▪ It has been an important indicator of the firm’s liquidity position and

is used as a complementary ratio to the current ratio.

▪ It establishes the relationship between quick assets and current

liabilities.

▪ It is calculated by dividing quick assets by the current liabilities.

Acid Test Ratio = Quick /Liquid Assets

Current liabilities

Quick /Liquid Assets = Current Assets – Stock – Prepaid Expenses –

Advanced Tax

CASH RATIO/ ABSOLUTE LIQUID RATIO

It shows the relationship between absolute liquid or super quick

current assets and liabilities. Absolute liquid assets include cash,
bank balances, and marketable securities.

Absolute liquid ratio = Absolute liquid assets

Current liabilities

Absolute Liquid Assets = Cash + Bank + Marketable Securities

(Market value of non trade Invest)
Example 1
Inventories 50,000 Trade receivables 50,000 Advance tax 4,000 Cash
and cash equivalents 30,000 Trade payables 1,00,000 Short-term
borrowings (bank overdraft) 4,000
Calculate Current Ratio and Quik Ratio and Cash Ratio

Example 2
X Ltd., has a current ratio of 3.5:1 and quick ratio of 2:1. If excess of
current assets over quick assets represented by inventories is Rs.
24,000, calculate current assets and current liabilities.

2. SOLVENCY RATIO/ LEVERAGE RATIO

▪ The solvency or leverage ratios throws light on the long-term

solvency of a firm

▪ These Ratios reflect firms' ability to assure the long term creditors
with regard to periodic payment of interest during the period and
loan repayment of principal on maturity.

▪ These ratios explain

a. Ability to repay the principal amount as and when due
b. Regular payment of the interest.

▪ Solvency ratios generally Includes following:

1. Debt equity ratio
2. Debt to total Assets ratio
3. Proprietary ratio
4. Interest coverage Ratio
5. Fixed charge coverage ratio
6. Capital Gearing Ratio

DEBT-EQUITY RATIO

▪ Debt equity ratio shows the relative claims of Long term creditors
and Shareholders fund (Equity).
▪ Thus this ratio indicates the relative proportions of debt and equity
in financing the firm’s assets.
▪ It can be calculated by dividing Debt by shareholder funds (Equity)
▪ Ideal Ratio id 2:1

Debt equity ratio = Total Debts

Shareholder Funds or Equity
Total Debts includes long-term debts only.
The shareholder funds include
▪ Equity share capital
▪ Preference share capital
▪ Reserves and surplus including accumulated profits.

However fictitious assets like accumulated losses and deferred

expenses etc. should be deducted from the total of these items to
arrive at shareholder funds.

The shareholder funds so calculated are known as net worth of the

business.

DEBT TO TOTAL ASSETS RATIO

▪ This ratio show the share of Debts in Total Assets of the Firm
▪ It is calculated as under

Debt equity ratio = Total Debts

Total Assets

Total Debts includes long-term debts only.

The Assets do not includes Fictitious Assets

CAPITAL GEARING RATIO

▪ This ratio show the share of Relation of Fixed Capital with equity
shareholders fund

Debt equity ratio = Total Debts + PSC

shareholder's Equity shareholders fund

Equity Shareholders fund = ESC + R&S

Example 3
ES Capital 15,00,000
PS Capital 6,00,000
Reserve & Surplus 4,00,000
Long Term Debts 13,50,000
Current Liabilities 4,50,000

Calculate:
(i) Debt – Equity Ratio
(ii) Debts to Total Assets Ratio
(iii) Capital Gearing Ratio
 INTEREST COVERAGE RATIO

This shows the number of times the earnings of the firms are able to
cover the fixed interest liability of the firm. This ratio therefore is also
known as Interest coverage or time interest earned ratio. It is
calculated by dividing the earnings before interest and tax (EBIT) by
interest charges on loans.

Debt Service Ratio = Earnings before interest and tax (EBIT)

Interest Charges

Example 4
From the following details, calculate interest coverage ratio: Net Profit
after tax Rs. 60,000; 15% Long term debt 10,00,000; and Tax rate 40%.

DEBTS SERVICE COVERAGE RATIO

This ratio shows how many times the cash flow before interest and
taxes covers Interest and Repayment of Loan. It is defined as:
Profit before interest and taxes + Depreciation
Repayment of loan Installment + Interest

Example 5
From the following details, calculate interest coverage ratio: and Debts
service coverage Ratio. Net Profit after tax Rs. 1,00,000; 15% Long
term debt 10,00,000 repayable in 20 Installments; Depreciation Rs.
1,50,000 and Tax rate 40%.

FIXED CHARGE SERVICE COVERAGE RATIO

This ratio shows how many times the cash flow before interest and
taxes covers all fixed financing charges. It is defined as:

Profit after tax +Depreciation +Other non-cash charges

Interest on term loan + Lease rentals
Interest on term loan + Lease rentals + Repayment of term loan

Example 6
Company A records EAT of Rs. 300,000, operating lease payments of
Rs. 200,000, and Rs. 50,000 in interest expense. Calculate Fixed
Charges Coverage Ratio.
 INTEREST COVERAGE RATIO

This shows the number of times the earnings of the firms are able to
cover the fixed interest liability of the firm. This ratio therefore is also
known as Interest coverage or time interest earned ratio. It is
calculated by dividing the earnings before interest and tax (EBIT) by
interest charges on loans.

Debt Service Ratio = Earnings before interest and tax (EBIT)

Interest Charges

Example 4
From the following details, calculate interest coverage ratio: Net Profit
after tax Rs. 60,000; 15% Long term debt 10,00,000; and Tax rate 40%.

DEBTS SERVICE COVERAGE RATIO

This ratio shows how many times the cash flow before interest and
taxes covers Interest and Repayment of Loan. It is defined as:
Profit before interest and taxes + Depreciation
Repayment of loan Installment + Interest

Example 5
From the following details, calculate interest coverage ratio: and Debts
service coverage Ratio. Net Profit after tax Rs. 1,00,000; 15% Long
term debt 10,00,000 repayable in 20 Installments; Depreciation Rs.
1,50,000 and Tax rate 40%.

FIXED CHARGE SERVICE COVERAGE RATIO

This ratio shows how many times the cash flow before interest and
taxes covers all fixed financing charges. It is defined as:

Profit after tax +Depreciation +Other non-cash charges

Interest on term loan + Lease rentals
Interest on term loan + Lease rentals + Repayment of term loan

Example 6
Company A records EAT of Rs. 300,000, operating lease payments of
Rs. 200,000, and Rs. 50,000 in interest expense. Calculate Fixed
Charges Coverage Ratio.
 3. TURNOVER RATIO/ ACTIVITY RATIO

Turnover ratios are also known as activity ratios or efficiency ratios

with which a firm manages its Operations. The following turnover
ratios can be calculated to judge the effectiveness of asset use.

1. Inventory Turnover Ratio

2. Debtor Turnover Ratio
3. Creditor Turnover Ratio
4. Assets Turnover Ratio

INVENTORY TURNOVER RATIO

This ratio indicates the number of times the inventory has been
converted into sales during the period. Thus it evaluates the efficiency
of the firm in managing its inventory. It is calculated by dividing the
cost of goods sold by average inventory.

Inventory Turnover Ratio = Cost of goods sold

Average Inventory

The average inventory is simple average of the opening and closing

balances of inventory. (Opening + Closing balances / 2).

In certain circumstances opening balance of the inventory may not be

known then closing balance of inventory may be considered as
average inventory

Cost of Goods sold =

Opening stock + Purchase + Direct Expenses – Closing Stock
or

Sales - GP

Example 7
From the following information, calculate inventory turnover ratio :

Inventory in the beginning = 18,000 Inventory at the end = 22,000

Net purchases = 46,000 Wages = 14,000
Revenue from operations = 80,000 Carriage inwards = 4,000

Example 8
From the following information, calculate inventory turnover ratio :

Revenue from Operation 4,00,000

Average Inventory 55,000
GP Ratio 10%
 DEBTORS TURNOVER RATIO

This indicates the number of times average debtors have been

converted into cash during a year. It is determined by dividing the net
credit sales by average debtors.

Debtor Turnover Ratio = Net Credit Sales

Average Trade Debtors

Net credit sales consist of gross credit sales minus sales return.
Trade debtor includes sundry debtors and bill’s receivables. Average
trade debtors (Opening + Closing balances / 2)

When the information about credit sales, opening and closing balances
of trade debtors is not available then the ratio can be calculated by
dividing total sales by closing balances of trade debtor

Debtor Turnover Ratio = Total Sales

Trade Debtors

Average collection period = 365/12

DTR

Example 9
Calculate the Trade receivables turnover ratio and Average collection
period:
Total Revenue from operations 4,00,000
Cash Revenue from operations 20% of Total Revenue from operations
Trade receivables as at 1.4.2021 40,000
Trade receivables as at 31.3.2022 1,20,000

FIXED ASSETS TURNOVER RATIO

This ratio measures sales per rupee of investment in fixed assets. It is

defined as:
Fixed Assets Turnover Ratio = Net Sales
Average Fixed Assets

TOTAL ASSETS TURNOVER RATIO

Total Assets Turnover: the total assets turnover is defined as:

Assets Turnover Ratio = Net Sales
Average Total Assets

This ratio measures how efficiently assets are employed, overall.

 4. PROFITABILITY RATIO

GROSS PROFIT RATIO

It measures the relationship between gross profit and sales. It is
calculated by dividing gross profit by sales.
Gross profit margin or ratio = Gross profit X 100
Net sales

Gross profit is the difference between sales and cost of goods sold.

OPERATING PROFIT RATIO

It measures the relationship between Operating profit and sales. It is
calculated by dividing EBIT profit by sales.
EBIT X 100
Net sales

EBIT = Net Sales – Operating cost

Operating Cost = Cost of Goods sold + Operating Expenses
All Expenses other than Interest are Operating Expenses

OPERATING RATIO
It measures the relationship between Operating cost and sales. It is
calculated by dividing operating cost by sales.
operating cost X 100
Net sales

Operating ratio may also be calculated as under:

100 – Operating profit ratio

EBITDA Margin
The EBITDA margin is defined as
EBITDA X 100
Net sales

EBITDA = Earning before Interest Tax, Depreciation and Amortization

NET PROFIT RATIO

It measures the relationship between Net profit and sales.
It is calculated by dividing gross profit by sales.
Net profit margin or ratio = Net profit X 100
Net sales
 5. PROFITABILITY RATIO BASED ON OVERALL RETURN
ON INVESTMENTS

Return on Capital Employed / on Investment (ROCE/ROI)

Before Tax= EBIT
Capital Employed

After Tax= EBIT X (1 – tax)

Capital Employed

Capital Employed =
F 1 = Total Assets – Current Liabilities
F 2 = Share capital + R&S + Long Term Debts – Accumulated Losses

Return on Assets (ROA)

The return on assets (ROA) is defined as:

Before Tax= EBT

Total Assets

After Tax= EAT

Total Assets

Return on Equity (ROE)

The ROE is calculated as under
Earning for equity shareholders
Equity shareholders fund

Earning for Equity is calculated as

EBIT – I = EBT – Tax = EAT – Pref Dividend

Equity share holders fund = Equity Share capital + R & S

Example 10
Equity Share Capital 20,00,000
10% PS Capital 5,00,000
R&S 10,00,000
12% Debts 18,00,000
Current Liabilities 10,00,000
EBIT 9,00,000
Tax Rate 30%
Calculate (i) ROCE (ii) ROA (iii) ROE
 6. PROFITABILITY RATIO BASED ON OWNER’S POINT
OF VIEW AND BASED ON MARKET

EPS (Earning Per share)

Earning for equity shareholders
No of Equity Share

Earning for Equity is calculated as

EBIT – I = EBT – Tax = EAT – Pref Dividend

DPS (Dividend Per share)

Dividend Distributed
No of Equity Share

DIVIDEND PAYOUT RATIO

DPS X 100
EPS

RETENTION RATIO = 100 – Dividend payout ratio

PRICING EARNING RATIO

Market Price per share (MPS)
Earning per share (EPS

EARNING YILED
EPS X 100
MPS

DIVIDEND YILED
DPS X 100
MPS
 7. DU PONT ANALYSIS

Under this Analysis, Return on Equity is analyzed by

comparing Net Profit ratio, Assets Turnover Ratio and
Financial Leverage

NET PROFIT RATIO

NET PROFIT X 100
SALES

ASSETS TURNOVER RATIO

SALES
ASSETS

FINANCIAL LEVERAGE
ASSETS
EQUITY

RETURN ON EQUITY UNDER DU PONT ANALYSIS WILL BE

NET PROFIT X SALES X ASSETS

SALES ASSETS EQUITY

Example
Net Profit 2,00,000
Sales 10,00,000
Equity 12,50,000
Assets 15,00,000

Calculate Return on Equity by Du Pont Analysis