5.5 Analysis of accounts Flashcards
What is the analysis of accounts?
Using data in the accounts to make useful observations about a business’s performance and financial strength.
What is liquidity?
The ability of a business to pay back its short-term loans (debts).
What is an illiquid asset?
An asset that is not readily convertible into cash.
What is profitability?
Measurement of the profit made relative to sales or capital invested in the business, indicating efficiency.
What are profitability ratios?
Ratios that measure how profitable a business is.
What are liquidity ratios?
Ratios that measure how able a business is to pay its short-term debts.
What is the gross profit margin (GPM)?
The percentage of sales converted into gross profit.
What does a high gross profit margin indicate?
It indicates a business is efficient at converting sales into profit.
What is the net profit margin (NPM)?
The percentage of sales converted into net profit.
What does the net profit margin show?
How well a company converts sales into net profit.
What is the return on capital employed (RoCE)?
How profitable a company is relative to the capital used.
What does a high RoCE indicate?
It shows the business is generating more net profit from its sales.
What is the importance of using multiple profitability ratios?
One ratio alone is not helpful; comparing multiple ratios helps in analyzing the overall performance.
What is the current ratio?
A measure of a company’s ability to pay off its current liabilities with its current assets.
What does a current ratio of less than 1 indicate?
It means the business does not have enough assets to cover its short-term debts.
What does a current ratio of 1 mean?
It means the business can exactly pay off its short-term debts.
What does a current ratio greater than 2 indicate?
It shows the business has excessive assets that could be put to better use.
What is the acid test ratio?
A measure of a company’s ability to pay off liabilities without depending on inventory sales.
What is the formula for the acid test ratio?
Acid Test Ratio = (Current assets - Inventories) / Current liabilities.
What is the acid test ratio’s purpose?
It considers only liquid assets, not inventories, and helps assess a business’s ability to pay short-term debts.
Who uses accounting information?
Managers, shareholders, creditors, banks, government, workers, trade unions, and competitors.
How do managers use accounting information?
To control product performance and make decisions based on ratios.
How do shareholders use accounting information?
To assess profitability and liquidity, helping them decide on buying more shares.
How do creditors use accounting information?
To assess the company’s ability to pay back debts based on liquidity ratios.
How do banks use accounting information?
To assess the risk of lending based on the company’s liquidity.
How does the government use accounting information?
To check whether the business is paying the correct amount of taxes.
How do workers and trade unions use accounting information?
To assess whether the company is secure and can improve wages and working conditions.
How do competitors use accounting information?
To compare profitability and liquidity ratios with other businesses.
What are the limitations of accounting records and ratio analysis?
Ratios are based on past data, affected by inflation, and may not predict future performance. Different companies may use different accounting methods, making comparisons difficult.
