Ratio Analysis: Liquidity, Solvency, Turnover, Profitability and Bank Ratios for RBI Grade B Finance

Last updated: 2026-11-13 · MockMentor

The syllabus line on accounting ends with "Ratio Analysis (such as Debt to Equity, Debtor Days, Creditor Days, Inventory Turnover, Return on Assets, Return on Equity, etc.)", and RBI has named these ratios for a reason: they are asked as numericals almost every year. In 2026, accounting and ratio questions were the largest single Finance topic in the objective paper. This chapter explains every important ratio with its formula, meaning and a worked example, and ends with the ratios used to judge banks.

In one line: ratio analysis compares figures from financial statements to judge a firm's liquidity (can it pay short-term bills?), solvency (can it carry its debt?), efficiency (how fast does it turn assets into sales and cash?), profitability (how much does it earn?) and market value.

Basic concepts

• Ratio: a relationship between two numbers, expressed as a pure number (2:1), a percentage (15%), a number of times (6 times) or a number of days (45 days).
• Ratio analysis: the use of ratios from financial statements to evaluate performance and financial position.
• Trend analysis: comparing a firm's ratios over several years.
• Cross-sectional analysis: comparing a firm's ratios with those of other firms or the industry average.
• Working capital: current assets minus current liabilities.
• Net worth (shareholders' equity): share capital plus reserves and surplus, minus accumulated losses.

Why in News?

1. Accounting and ratio numericals rose from three questions in the 2025 RBI Grade B Phase 2 Finance paper to six in 2026.
2. RBI's Financial Stability Reports continue to track bank ratios such as the gross NPA ratio, provision coverage ratio and capital adequacy, which show Indian banks at multi-year highs of health.
3. RBI's expected credit loss framework from April 2027 will change how provisions, and therefore net profit and return ratios of banks, are calculated.
4. The working capital cycle of MSMEs, shown by debtor days, remains a policy concern, which the TReDS platform and the 45-day payment rule for MSME dues aim to address.

Data used in the examples

All examples below use this company's figures (₹ lakh).

Current assets = 150 + 130 + 70 = 350. Current liabilities = 120 + 80 = 200. Net worth = 500.

Liquidity ratios

Liquidity ratios measure the ability to meet short-term obligations.

The quick ratio is a better test than the current ratio when inventory is large or hard to sell.

Solvency (leverage) ratios

Solvency ratios measure the ability to meet long-term obligations and the use of debt.

Cash available for debt service = Profit after tax + Depreciation + Interest (+ other non-cash charges). With PAT 112, depreciation 40 and interest 30, it is 182.

Financial leverage

Using debt raises the return to shareholders when the return on assets exceeds the cost of debt, but increases risk. The Degree of Financial Leverage = EBIT ÷ EBT = 180 ÷ 150 = 1.2. A 10% rise in EBIT would raise profit before tax by 12%.

Activity (turnover) ratios

Activity ratios measure how efficiently a firm uses its assets.

Inventory turnover

A higher turnover means stock sells quickly; too high may mean frequent stock-outs.

Debtors (receivables)

Lower debtor days mean faster collection from customers.

Creditors (payables)

Higher creditor days mean the firm takes longer to pay suppliers, which helps its cash flow but may hurt relations or signal stress.

Operating and cash conversion cycle

• Operating cycle = Inventory days + Debtor days = 91 + 47 = 138 days.
• Cash conversion cycle = Inventory days + Debtor days − Creditor days = 91 + 47 − 67 = 71 days.

The cash conversion cycle shows how long cash is tied up in operations. A shorter cycle means less need for working capital finance.

Other turnover ratios

Profitability ratios

Margins

Returns

ROE is higher than ROA because the firm uses debt. ROCE measures the return on all long-term funds, whatever their source.

DuPont analysis

DuPont analysis breaks ROE into three parts to show what drives it:

ROE = Net profit margin × Asset turnover × Equity multiplier

where Equity multiplier = Total assets ÷ Equity.

Example: 11.2% × 1.053 × (950 ÷ 500 = 1.9) = 11.2% × 1.053 × 1.9 = 22.4%.

So the firm's ROE comes from a moderate margin, average asset use and some leverage. Two firms with the same ROE may differ: one through high margins, another through high debt, which is riskier.

Market value ratios

A high P/E may mean investors expect strong growth, or that the share is overvalued. P/B is widely used to value banks.

Ratios used to analyse banks

Banks have different balance sheets, so analysts use specific ratios.

Example: a bank has gross advances of ₹10,000 crore, gross NPAs of ₹300 crore and provisions of ₹210 crore. Gross NPA ratio = 3%. Net NPAs = 90, so net NPA ratio ≈ 90 ÷ 9,790 = 0.92%. PCR = 210 ÷ 300 = 70%.

Uses of ratio analysis

1. Judging liquidity, solvency and profitability quickly.
2. Comparing performance over time and with other firms.
3. Credit appraisal by banks, which set covenants on ratios such as debt to equity and DSCR.
4. Investment decisions by shareholders.
5. Early warning of financial distress.
6. Planning and control by management.

Limitations

• Ratios are based on historical accounts and may not predict the future.
• Different accounting policies (such as depreciation methods) make comparisons misleading.
• Window dressing at the year end can distort ratios.
• Inflation affects comparisons over time.
• Ratios show symptoms, not causes; they need interpretation with other information.
• There is no single "ideal" value; it depends on the industry.

Possible exam and interview questions

1. Explain the main categories of financial ratios. Why do banks pay close attention to the debt to equity ratio and DSCR in credit appraisal? (620 words)
2. What is DuPont analysis? How does it help in understanding a firm's return on equity? (420 words)
3. A firm has credit sales of ₹730 lakh and trade receivables of ₹73 lakh. Calculate its debtors turnover and debtor days.
4. Explain the provision coverage ratio and the net interest margin of a bank.
5. Interview: Can a company with a current ratio of 3 still face a liquidity problem?

Related reading: accounting and financial statements, risk management and Basel norms, and time value of money.

More in Finance

• Financial System
• Functions of RBI
• Banking System
• Banking Reforms
• Financial Institutions

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