acCounting Made Simple 08 Flashcards
- What is the purpose of LIQUIDITY RATIOS?
They are used to determine how easily a company will be able to meet its short term financial obligations.
- What is the CURRENT RATIO?
(current assets/current liabilities)
- What is the purpose of the CURRENT RATIO?
It provides an assessment of the company’s ability to pay off its current liabilities using its current assets.
- What is the QUICK RATIO and what is its purpose?
[ (current assets-inventory) / current liabilities ].
It provides a worst case scenario assessment; how well will the company be able to fulfill its current LIABILITIES if sales are slow (if inventories cannot be converted into cash).
- A CURRENT RATIO of ( 40k + 100k + 60k / 50k + 150k ) = 1 means:
that the company’s current ASSETS match its current LIABILITIES, and it should not have any trouble handling its financial obligations over the next 12 months.
- A QUICK RATIO of [ (40k + 60k) / 50k + 150k ] = 0.5 indicates:
that the company will need to maintain at least some level of sales in order to satisfy its liabilities.
- Of the PROFITABILITY RATIOS, what is the RETURN ON ASSETS RATIO?
( net income / total assets ).
It shows us the company’s profitability in comparison to the company’s size ( as measured by total assets ). It answers the question, “How efficient is this company in using its assets to generate profits?”
- What is the RETURN ON EQUITY ( PROFITABILITY) RATIO?
( net income / shareholder’s equity ).
Note that shareholder’s equity is used in place of TOTAL ASSETS.
It asks the question, “ How efficiently is this company using it’s investor’s money to generate profits?”
- By using RETURN ON ASSETS or RETURN ON EQUITY, you can:
make meaningful comparisons between the profitability of TWO DIFFERENT COMPANIES, even if they are of very different sizes.
- What is the GROSS PROFIT MARGIN?
[ ( sales - cost of goods sold) / sales ].
It shows what percentage of sales remains after covering the cost of the sold inventory.
This gross profit is then used to cover overhead costs, with the remainder being the company’s net income.
ABC Construction’s total sales were 80k and the COGS was 20k. What was the GROSS PROFIT MARGIN for the year?
[ ( sales- GOGS ) / sales ) = (80k - 20k) / 80k = 75%.
- What is the use of the GROSS PROFIT MARGIN?
It is used to make comparisons between companies WITHIN an industry. The PROFIT MARGIN of two different grocery stores can give you an idea of which does a better job of keeping inventory costs low.
