Accounting Term 3 Ratios

Question 1

Financial reports definition

Answer 1

Financial reports are one means of communicating information, and the use of ratios greatly assists with the analysis and interpretation of these reports.

Question 2

Financial Stability definition

Answer 2

The financial stability ratios give an indication of the short-term liquidity and the long-term solvency of the enterprise.

Question 3

The current ratio definition

Answer 3

This ratio indicates the ability of an enterprise to meet its short-term financial obligations.

Question 4

Generally accepted current ratio

Answer 4

2:1

Question 5

Quick ratio definition

Answer 5

The quick ratio measures the ability of a business to meet its immediate financial obligations.

Question 6

Equity ratio definition

Answer 6

This ratio indicates the extent to which the owner has financed the business’s assets as opposed to using alternative source of finance - borrowings

Question 7

Debt ratio definition

Answer 7

This ratio indicates the way in which the business is financed and the extent of the business’s borrowings in relation to its assets.

Question 8

Profitability definition

Answer 8

Profitability is the ability to earn income within the current financial structure capacity.

Question 9

Gross profit ratio definition

Answer 9

The gross profit ratio indicates the ability of an enterprise to generate an acceptable net profit, return on owner’s investment and whether it can meet its other operating expenses.

Question 10

Net profit ratio definition

Answer 10

The purpose of the net profit ratio is to show the effectiveness of managers to minimise expenses per dollar of sales.

Question 11

Rate of return on owners equity ratio definition

Answer 11

The rate of return on owner’s equity ratio indicates the return on the owner’s investment in the business.

Question 12

Rate of return on total assets ratio definition

Answer 12

The rate of return on total assets ratio indicates the ability of the enterprise to generate profits using its assets.

Question 13

Management effectiveness definition

Answer 13

Effectiveness of management policies is the measurement of how proficient managers, have been in directing and maintaining set policies.

Question 14

Rate of turnover of inventories ratio definition

Answer 14

The rate of turnover of inventories ratio details how many times initial inventory are replaced.

Question 15

Rate of turnover of accounts receivable ratio definition

Answer 15

The rate of turnover of accounts receivable ratio indicates the period of collection of accounts receivable.

Question 16

Current ratio strategies

Answer 16

increase current assets

Decrease current liabilities - short term loans into long term loans

Question 17

Quick ratio strategies

Answer 17

Increase current assets such as cash

Decrease current liabilities

Question 18

Equity/Debt ratio strategies

Answer 18

Decrease debt through repayments
Minimise the need to hold large assets
Minimise the need to borrow beyond the 50:50 balance of debt/equity

Question 19

Gross profit ratio strategies

Answer 19

Increase selling price
Reduce COGS
Find a cheaper supplier for goods sold

Question 20

Net profit ratio strategies

Answer 20

Increase sale revenue

Reduce expenses

Question 21

Rate of return on OE strategies

Answer 21

Decrease owner’s investment if is considered to be overcapitalised
Increase net profit
The owner could contribute more capital of undercapitalised

Question 22

Rate of return on total assets ratio strategies

Answer 22

Increase net profit

Decrease average total assets

Question 23

Inventories strategies

Answer 23

Sell more inventories through targeting customers via phone sales, advertising or changing pricing policy
Quit items which are not moving quickly while ensuring a good supply of the most popular inventory items.

Question 24

Account receivable strategies

Answer 24

Tighten credit policy and communicate this to debtors
Follow up late payers by phone, email and letter if necessary
Offer discounts for early cash settlement
Use bright stickers on statements to debtors to remind them of overdue status of accounts
If bad debts are a concern, then are policies for determining who will receive credit being followed: Do they need review?

Question 25

Title

Answer 25

Evaluation of Financial Position - Name and Date

Question 26

Summary

Answer 26

State the level of operation - acceptable, not acceptable Compare to industry - compares favourably or unfavourably Recommendations have been made to address the issues that have arisen

Question 27

Introduction

Answer 27

Financial reports are one means of communication information, and the use of ratios greatly assists with the analysis and interpretation of these reports. Three areas; financial stability, earning capacity and effectiveness of management policies assist with analysing and interpreting the financial position of the firm. Each of these will be addressed independently in this report.

Question 28

Financial stability ratio structure

Answer 28

Define financial stability Cover the following for each ratio: (current, quick, equity and debt) State the 2017 figure Compare to industry average and 2016 State what is acceptable What strategies can be used to improve this ratio? What events or accounts have cause this result Include in your discussion - relevant horizontal and vertical analysis

Question 29

Current ratio what does high or low mean?

Answer 29

High ratio - high degree of assurance that current liabilities can be paid out of current assets. Low ratio - Low of above

Question 30

Quick ratio what does high or low mean?

Answer 30

High - high degree of assurance that current liabilities can be paid out of current assets Low - business is depending on inventory turnover to pay current debts

Question 31

Equity ratio what does high or low mean?

Answer 31

High - most funds are being provided by the owner | Low- most being provided by borrowings

Question 32

Debt ratio what does high or low mean?

Answer 32

Low - assets are being funded by the owner | High - assets being funded by borrowings

Question 33

Gross profit ratio what does high or low mean?

Answer 33

High - Business can easily cover all of its expenses; has the capacity to earn an acceptable net profit and an adequate return on investment Low - business will have difficulty in covering other expenses; a net loss may occur; there is an adequate return on investment.

Question 34

Net profit ratio what does high or low mean?

Answer 34

High - operating revenue is high and operating expenses are low Low - selling margin is very low; volume of sales is low compared to fixed costs; expenses are too high when compared to sales

Question 35

Rate of return on Owners Equity what does high or low mean?

Answer 35

High - may indicate management efficiency | Low - could be more beneficial for the owner to invest elsewhere

Question 36

Rate of return on Total Assets ratio what does high or low mean?

Answer 36

High - good performance of assets; effectiveness use of firm's assets to generate profit Low - Ineffective use of firm's assets; poor performance of assets

Question 37

Management effectiveness paragraphs structures

Answer 37

Define effectiveness of management policies Cover the following for each ratio: - state the 2017 figure - state what the ratio shows - Compare to industry average and 2016 - State what is acceptable - What strategies can be used to improve the ratio? - What accounts or events have caused this result? - Include your discussion - relevant horizontal and vertical analysis

Question 38

Inventories what does high or low mean?

Answer 38

High - fast moving inventory; shortage of inventory available for sale Low - slow moving inventory; large holding of inventory ready for sale

Question 39

Accounts receviable what does high or low mean?

Answer 39

High - tight and effective credit policy | Low - loose credit policy; in danger of a high number of bad debts

Question 40

Conclusion structure

Answer 40

STATEMENTS COVERING ALL RATIOS - Is the business able to meet its immediate and short term debts? - How the business is funded - internal or external and is there a balance? - The level of gross profit - satisfactory, unsatisfactory, good, excellent - Net Profit - what has happened, compare to industry average - Rate of Return on OE and total assets - what has happened, how does it compare to industry - Inventory turnover - has it improved - Accounts receivable - does the credit policy need urgent attention