While preparing a cash flow statement, dividend PAID by a manufacturing company is classified under:

It is not shown, being an appropriation

In the indirect method, depreciation is added back to net profit because it:

Reduced profit without any cash going out

Increases the value of the fixed asset

Reduced profit without any cash going out

A company with a current ratio of 0.8:1 pays 20,000 of its creditors in cash. The current ratio will:

Fall further, because the ratio was below 1 to begin with

Improve, because liabilities have fallen

Fall further, because the ratio was below 1 to begin with

Stay unchanged, since both sides fall equally

In a common-size Statement of Profit and Loss, every item is expressed as a percentage of:

The previous year’s figure for the same item

A machine costing 50,000 with accumulated depreciation of 30,000 is sold for 25,000. In the cash flow statement:

25,000 is an investing inflow and the 5,000 profit is subtracted from operating profit

20,000 is an investing inflow and 5,000 an operating inflow

Nothing is shown, since the machine was already depreciated

Analysis of Financial Statements — Ratios and the Cash Flow Statement

A balance sheet says what a company has; analysis says whether that is enough. The unit has three instruments and each answers a different question. Comparative and common-size statements ask how the figures moved, one restating everything as a change and the other as a percentage of a base. Ratios ask whether the company can pay its bills (liquidity), survive its debt (solvency), use its assets (activity) and earn a return (profitability). And the cash flow statement asks the question a profit figure cannot answer — where the cash went — by sorting every movement into operating, investing or financing. The paper asks all three as computation, so the formulas below are given with the classification each item takes, which is where most marks are actually lost.

The Ratios, Grouped by the Question They Answer

The ratios CUET sets, with the formula and the standard reading
Ratio	Formula	What it tells you
Current ratio	Current assets ÷ current liabilities	Short-term solvency. 2:1 is the conventional benchmark; far above it can mean idle stock or uncollected receivables rather than strength.
Quick ratio	(Current assets − inventory − prepaid expenses) ÷ current liabilities	The same test with the least liquid assets removed. 1:1 is the benchmark.
Debt-equity ratio	Long-term debt ÷ shareholders’ funds	Long-term solvency and the degree of gearing. 2:1 is the conventional ceiling.
Inventory turnover ratio	Cost of revenue from operations ÷ average inventory	How many times stock is sold and replaced in the year — an activity ratio, expressed in times and not in rupees.
Trade receivables turnover	Net credit revenue from operations ÷ average trade receivables	How fast credit sales are collected. 365 divided by it gives the average collection period in days.
Gross profit ratio	(Gross profit ÷ revenue from operations) × 100	Margin before indirect costs. Always taken on revenue, never on cost.
Return on investment	(Profit before interest and tax ÷ capital employed) × 100	The overall earning power of all the long-term funds, whoever supplied them — which is why the numerator is before interest.

⚠️ Two ratios move in opposite directions on the same event

Paying a current liability out of cash reduces both sides of the current ratio by the same amount, so a ratio above 1 goes UP and a ratio below 1 goes DOWN — the direction depends on where it started, which is the standard "what will be the effect" question. Buying inventory on credit leaves the current ratio's numerator and denominator both higher but worsens the quick ratio, because inventory is excluded from the numerator. Work these by substituting small numbers rather than by intuition; the effect is arithmetic, not judgement.

The Cash Flow Statement: Three Baskets

Every movement of cash goes into exactly one of three activities, and almost every mark in this unit is for putting an item in the right one. Operating is the trading business — cash from customers, cash to suppliers and employees, and, computed by the indirect method, net profit before tax adjusted for non-cash charges such as depreciation and for changes in working capital. Investing is buying and selling long-term assets and investments, and the interest and dividend RECEIVED on them. Financing is raising and repaying capital — issuing shares or debentures, repaying a loan — and the interest and dividend PAID on them.

Depreciation is added back in the indirect method: it reduced profit without any cash leaving, so removing it converts an accounting profit towards a cash figure. The same goes for goodwill written off, loss on sale of an asset, and a provision created.
Profit on sale of a fixed asset is subtracted from operating profit and the whole sale proceeds appear under investing — otherwise the same gain is counted twice.
A financing company is the exception: for it, interest and dividend received are operating activities, because lending IS its business. CUET has asked this directly.
Cash and cash equivalents are cash, bank balances and short-term highly liquid investments; a bank overdraft is treated as a financing activity in this syllabus, not as negative cash.

Comparative and Common-Size Statements

Both restate the same statement, and the difference is the base. A comparative statement puts two years side by side and adds the absolute change and the percentage change on the earlier year — so it answers "what moved, and by how much". A common-size statement expresses every line as a percentage of one base: revenue from operations for the Statement of Profit and Loss, and total assets (or total equity and liabilities) for the balance sheet — so it answers "what is the shape of this business", and it is what lets a small company be compared with a large one. Read the base off the question before computing: the same figure is a different percentage in each.

Key takeaways

Liquidity is the current ratio (2:1) and the quick ratio (1:1, inventory and prepaid expenses removed); solvency is debt-equity (2:1 ceiling); activity is turnover, expressed in times; profitability is a percentage, and gross profit ratio is always taken on revenue.
Paying a current liability in cash pushes a current ratio above 1 higher and one below 1 lower — the direction depends on where it started. Substitute small numbers rather than trusting intuition.
Interest and dividend RECEIVED are investing; interest and dividend PAID are financing — except for a financing company, where receipts are operating because lending is its business.
In the indirect method, depreciation and other non-cash charges are added back and profit on sale of an asset is subtracted, with the whole sale proceeds shown under investing — otherwise the gain is counted twice.

Practice questions (8)

Attempt each one before opening the answer. Every explanation names the tempting wrong option as well as the right one, because that is where marks are lost.

Current assets are 3,00,000 including inventory of 1,00,000, and current liabilities are 1,00,000. The quick ratio is:
1. 3:1
2. 2:1
3. 1:3
4. 4:1
Show answer
Answer: B — 2:1
The quick ratio excludes inventory, so quick assets are 3,00,000 − 1,00,000 = 2,00,000 against current liabilities of 1,00,000, giving 2:1. Answering 3:1 computes the current ratio instead and is the commonest error, since the inventory figure is given precisely so that it can be removed. 1:3 inverts the ratio, and a liquidity ratio is always assets to liabilities. 4:1 has no basis in the figures. Note also that prepaid expenses would come out along with inventory if the question gave any.
While preparing a cash flow statement, dividend PAID by a manufacturing company is classified under:
1. Operating activities
2. Financing activities
3. Investing activities
4. It is not shown, being an appropriation
Show answer
Answer: B — Financing activities
Dividend paid is a return to the providers of capital, so it belongs to financing activities along with interest paid, share issues and loan repayments. Operating is the trading business and would be right only for a financing company's receipts, not for anybody's dividend payment — mixing up the received and paid directions is the standard error here. Investing covers interest and dividend RECEIVED, which is the mirror item. And being an appropriation of profit does not exempt it: the cash flow statement follows cash out of the door, whatever the item is called in the profit statement.
In the indirect method, depreciation is added back to net profit because it:
1. Increases the value of the fixed asset
2. Reduced profit without any cash going out
3. Is a financing activity
4. Will be paid in the next year
Show answer
Answer: B — Reduced profit without any cash going out
Depreciation is a non-cash charge: it lowers accounting profit while no money leaves the business, so adding it back moves the figure towards cash generated from operations. Depreciation reduces rather than increases the carrying value of the asset, so that option is wrong on the direction as well as on the reason. Classifying it as financing confuses a book entry with a movement of funds; depreciation is not a cash flow of any kind. And it is never paid to anybody, in this year or the next — which is exactly why it has to be reversed out.
A company with a current ratio of 0.8:1 pays 20,000 of its creditors in cash. The current ratio will:
1. Improve, because liabilities have fallen
2. Fall further, because the ratio was below 1 to begin with
3. Stay unchanged, since both sides fall equally
4. Become exactly 1:1
Show answer
Answer: B — Fall further, because the ratio was below 1 to begin with
Substitute numbers: current assets 80,000 and liabilities 1,00,000 give 0.8. Paying 20,000 leaves 60,000 against 80,000, which is 0.75 — lower. Subtracting the same amount from both sides pushes a ratio further from 1 in whichever direction it already was, so a ratio above 1 rises and one below 1 falls. "Improve because liabilities have fallen" reasons from one side only and is the answer intuition gives. "Unchanged" would be true of a difference, not of a ratio. And landing exactly on 1:1 would need the payment to equal the gap between the two sides, which nothing in the question says.
Revenue from operations is 5,00,000 and gross profit is 1,00,000. The gross profit ratio is:
1. 25%
2. 20%
3. 16.67%
4. 80%
Show answer
Answer: B — 20%
The gross profit ratio is gross profit as a percentage of revenue from operations: (1,00,000 ÷ 5,00,000) × 100 = 20%. Taking it on cost of goods sold instead gives 1,00,000 ÷ 4,00,000 = 25%, which is the mark-up rather than the margin and is the commonest error in this item. 16.67% divides by the wrong total altogether. And 80% is the cost ratio, the complement of the answer, which is a useful cross-check: gross profit ratio and the cost-to-revenue ratio must add to 100.
In a common-size Statement of Profit and Loss, every item is expressed as a percentage of:
1. Total assets
2. Revenue from operations
3. Net profit for the year
4. The previous year’s figure for the same item
Show answer
Answer: B — Revenue from operations
A common-size income statement uses revenue from operations as the base of 100, which is what lets two companies of very different size be compared line by line. Total assets is the base for a common-size BALANCE SHEET, and swapping the two bases is the error this question is set on. Net profit is a result rather than a base, and using it would make the statement unreadable in a loss year. And expressing an item against the previous year's figure is what a COMPARATIVE statement does — that is the percentage change, not a common-size percentage.
Cost of revenue from operations is 6,00,000, opening inventory 80,000 and closing inventory 1,20,000. The inventory turnover ratio is:
1. 5 times
2. 6 times
3. 7.5 times
4. 60,000
Show answer
Answer: B — 6 times
Average inventory is (80,000 + 1,20,000) ÷ 2 = 1,00,000, so the ratio is 6,00,000 ÷ 1,00,000 = 6 times. Dividing by closing inventory alone gives 5 and by opening inventory alone gives 7.5 — both are the error of skipping the average, and the two figures are deliberately unequal so that the shortcut shows. The rupee answer fails on the unit: a turnover ratio is a number of times, and an activity ratio that comes out in rupees has been computed the wrong way round.
A machine costing 50,000 with accumulated depreciation of 30,000 is sold for 25,000. In the cash flow statement:
1. 25,000 is an operating inflow
2. 25,000 is an investing inflow and the 5,000 profit is subtracted from operating profit
3. 20,000 is an investing inflow and 5,000 an operating inflow
4. Nothing is shown, since the machine was already depreciated
Show answer
Answer: B — 25,000 is an investing inflow and the 5,000 profit is subtracted from operating profit
The book value is 50,000 − 30,000 = 20,000, so selling at 25,000 gives a profit of 5,000. The whole 25,000 actually received is an investing inflow, and the 5,000 profit — which is already inside net profit — is subtracted in the operating section so that the same gain is not counted twice. Calling the receipt operating misclassifies the sale of a fixed asset. Splitting it 20,000 and 5,000 is the seductive wrong answer because the arithmetic looks tidy, but no cash of 5,000 arrived separately. And "nothing is shown" ignores 25,000 of cash that genuinely came in.