Accounting Indicator questions

Question 1

Explain how it is possible for the Return on Assets to improve even though the Net Profit Margin declined (2 marks)

Answer 1

• Asset Turnover has increased, meaning sales have increased by a greater percentage than the percentage increase in assets
• even though AT has increased, it is the worsening of expense control that has caused Net Profit Margin to decrease
• though the increase in AT has had a proportionately larger impact than the decrease in the NPM, resulting in an increase in the ROA

Question 2

Explain how the decrease in Debt Ratio could negatively impact Return on Owner’s Investment. (2 marks)

Answer 2

• A decrease in debt ratio means the business has less reliance on borrowed funds, and a greater reliance on the owner’s capital
• likely a negative impact on ROI, as any increase in profit would have to increase by a greater proportion than the percentage increase in capital for there to be an increase in ROI

Question 3

Explain how the decrease in the Debt Ratio could positively impact the business’ stability (2 marks)

Answer 3

• Stability refers to the ability of the business to meet its debts and continue its operations in the long term
• decrease in debt ratio would generally have a positive effect on the business to continue its operations in the long term due to a decrease in interest expense, loans being paid faster, and a relative increase in O/E

Question 4

Explain how it is possible that the Working Capital Ratio increasing is favourable while the Quick Asset Ratio decreasing is unfavourable (2 mrks)

Answer 4

• Inventory and prepayments are both included in the calculation of WCR, but not in QAR calcula
  tion
• an increase in inventory levels may lead to a higher WCR without affecting QAR

Question 5

Explain the relationship between the increase in the Gross Profit Margin and the slowing of Inventory Turnover (2 marks)

Answer 5

• An increase in GPM likely indicates an increase in markup, most likely due to an increased markup
• increase in selling price has likely resulted in taking longer to sell inventory, indicated by the slower ITO

Question 6

Explain the relationship between the Working Capital Ratio and the Quick Asset Ratio. (3 marks)

Answer 6

• WCR compares the CA of a business against its CL
• QAR compares CA less inventory and pre-payments against CL
• reducing gap indicates business is reducing reliance on inventory and prepayments/growing gap indicates greater reliance

Question 7

Explain the implication of the increase in the Debt Ratio on the Cash Flow Cover (3 marks)

Answer 7

• higher debt ratio means a greater reliance on borrowed funds
• due to an increase in borrowings, a larger proportion of cash flows from operating is being used to repay CL
• This can be due to combination of increased interest paid on the borrowings and the increase in loan repayments, increasing CL

Question 8

How can the Working Capital Ratio can be declining while the
Quick Asset Ratio is not? (3 marks)

Answer 8

• define WCR
• define QAR
• owner may have drastically reduced level of inventory being held
• this change could also be affected by inventory write-downs and the consumption of prepaid expenses