Mandatory requirement for disclosure of accounting ratios in Ind AS Financial Statement

Mandatory requirement for disclosure of accounting ratios in Ind AS Financial Statement

Mandatory requirement for disclosure of accounting ratios in Financial Statement

In order to bring greater transparency and to improve the quality of reporting in the financial statements, an amendment to Schedule III to the Companies Act, 2013 was introduced by the Ministry of Corporate Affairs (MCA) vide notification dated 24.03.2021. These amendments were brought to align the reporting framework in accordance with the reporting requirement of CARO 2020. Wherein, several new disclosures grouped under "Additional Regulatory Information" such as title deeds of Immovable Property not held in the name of the Company, Fair valuation of investment property, Revaluation of Property, Loans or advances to specified persons, etc. are also to be provided in the Financial Statements. The disclosure if effective from 01.04.2021.

Disclosure of the following 11 key accounting ratios is one among such additional regulatory information that is mandatory to be provided in the Financial Statements.

 (a) Current ratio

 (b) Debt-equity ratio

 (c) Debt service coverage ratio

 (d) Return on equity ratio

 (e) Inventory turnover ratio

 (f) Trade receivables turnover ratio

 (g) Trade payables turnover ratio

 (h) Net capital turnover ratio

 (i) Net profit ratio

 (j) Return on capital employed

 (k) Return on investment

An explanation shall be provided for all the items included in the numerator and denominator for computing the above ratios. Also, where the change in such ratios is more than 25% (whether positive or negative)in comparison to the preceding year's ratio, a commentary explaining such change shall be provided.

The same may be provided in the manner below:

 

Ratio      Numerator      Denominator      Current Period      Previous Period      % variance      Reason for Variance
             

Further, if there is any change in the current period in relation to any item in the numerator or denominator of any ratio, then the same change shall be made for the comparative period as well and a footnote explaining the change in the item shall be added along with the reason thereof.

For Example, during the current Financial Year(FY) old appearing balance of trade receivables amounting to Rs. 80 Lakhs were found bad and accordingly the same was written off from the books of account in the current FY. The current ratio of the company was also computed by taking the reduced amount of trade receivables i.e. after write-off of Rs. 80 Lakhs. But, in the previous FY, such an amount( Rs. 80 Lakhs) was also considered for computing the current ratio.

Hence, as per the requirement of Schedule III, such reduction shall also be done in the respective figures of the comparative period (i.e. previous financial year) for fair analysis.

It should also be noted that the ratios presented in any other place in the annual report should be consistent with the ratios mentioned in the financial statement.

Calculation of Analytical Ratios and their Objective

  1. Current Ratio

The current ratio indicates a company's overall liquidity position. It analyses the ability of the company to meet short term liabilities. It is widely used by banks in making decisions regarding the advancing of working capital credit to their clients.

  Current Ratio = Current Assets  
  Current Liabilities  

A generally acceptable current ratio is 2:1, but, whether a particular ratio is acceptable or not, also depends upon the nature of business and characteristics of current assets and liabilities.

  2. Debt - Equity Ratio

Debt-to-equity ratio compares a Company's total debt to shareholders' equity. Both of these numbers can be found in a Company's balance sheet. This ratio is most often used for making capital structure decisions. A lower ratio indicates a strong equity position. Whereas, a higher ratio shows that the company is using more leverage.

  Debt-to-equity ratio= Total Debt  
  Shareholder's Equity  

  3.Debt Service Coverage Ratio(DSCR)

This ratio is used to find out the entity's ability to pay off its debt payments i.e interest and installments. Normally, DSCR of 1.5 to 2 is considered satisfactory.

  Debt Service Coverage Ratio= Earnings available for debt service  
  Debt service  

Earning for Debt Service = Net Profit after taxes + Non-cash operating expenses like depreciation and other amortizations + Interest + other adjustments like loss on sale of Fixed assets etc.

Debt service = Interest & Lease Payments + Principal Repayments

"Net Profit after tax" means the reported amount of "Profit / (loss) for the period" and it does not include items of other comprehensive income.

  4.Return on Equity (ROE):

It measures the profitability of equity funds invested in the Company. It also measures the percentage return generated to equity-holders. The ratio is computed as:

  ROE= Net Profits after taxes - Preference Dividend (if any)  
  Average Shareholder's Equity  

Average Shareholder's Equity= (Beginning shareholder's Equity + Ending Shareholder's Equity/2)

  5.Inventory Turnover Ratio

This ratio is also known as the stock turnover ratio. It measures the efficiency with which a Company utilizes or manages its inventory. It ascertains the number of times inventory has been created and sold during a period. The high inventory turnover ratio reflects the high use/ sale of inventory and is considered good from the viewpoint of liquidity.

  Inventory Turnover ratio= Cost of goods sold OR sales  
  Average Inventory  

Average inventory is (Opening + Closing balance / 2)

When the information opening and closing balances of inventory is not available then the ratio can be calculated by dividing COGS OR Sales by closing balance of Inventory.

  6.Trade receivables turnover ratio

It measures the efficiency at which the firm is managing the receivables. It ascertains the number of time trade receivables are turned into cash during the period. The high ratio reflects that collections are more rapid, whereas the low ratio reflects liberal credit terms granted to customers.

  Trade receivables turnover ratio= Net Credit Sales  
  Average accounts receivable  

Net credit sales consist of gross credit sales minus sales return. Trade receivables includes sundry debtors and bills receivables.

Average trade debtors = (Opening + Closing balance / 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 receivables.

  7.Trade payables turnover ratio

It indicates the number of times sundry creditors have been paid during a period and is calculated to judge the requirements of cash for paying sundry creditors. The high ratio reflects that accounts are settled more rapidly, whereas the low ratio reflects liberal credit terms granted by suppliers.

  Trade payables turnover ratio= Net Credit Purchases  
  Average Trade Payables  

Average trade payables = (Opening + Closing balance / 2)

Net credit purchases consist of gross credit purchases minus purchase return.

When the information about credit purchases, opening and closing balances of trade creditors is not available then the ratio is calculated by dividing total purchases by the closing balance of trade creditors.

  8.Net capital turnover ratio

It indicates a company's effectiveness in using its working capital. The working capital turnover ratio is calculated as follows:

  Net capital turnover ratio = Net Sales  
  Working capital  

Net sales shall be calculated as total sales minus sales returns. Working capital shall be calculated as current assets minus current liabilities.

  9.Net profit ratio

It measures the relationship between net profit and sales of the business. A high Net profit indicates high positive returns from the business.

  Net Profit Ratio= Net Profit  
  Net Sales  

Net profit shall be after tax.

Net sales shall be calculated as total sales minus sales returns.

  10.Return on capital employed (ROCE)

This ratio measures the company's ability to generate returns on the available capital base. i.e. or both the debt holders and the equity holders. It is an important ratio for analysts and management. The higher the ratio, the more efficiently capital is employed by the company to generate returns. ROCE should always be higher than the rate at which company borrows.

  ROCE = Earning before interest and taxes  
  Capital Employed  

Capital Employed = Tangible Net Worth + Total Debt + Deferred Tax Liability

11.Return on investment

Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will receive in relation to their investment cost. The higher the ratio, the greater the benefit earned. One of the widely used methods is Time-Weighted Rate of Return (TWRR) and the same should be followed to calculate ROI. It adjusts the return for the timing of investment cash flows and its formula/method of calculation is commonly available. However, the same is given below for quick reference:

  ROI = {MV(T1) - MV(T0) - Sum [C(t)]{  
  {MV(T0) + Sum [W(t) * C(t)]{  

Where,

T1 = End of time period

T0 = Beginning of time period

t = Specific date falling between T1 and T0

MV(T1) = Market Value at T1

MV(T0) = Market Value at T0

C(t) = Cash inflow ,cash outflow on specific date

W(t) = Weight of the net cash flow (i.e. either net inflow or net outflow) on day 't', calculated as [T1 - t] / T1

Companies may provide ROI separately for each asset class (e.g., equity, fixed income, money market, etc.).