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Edexcel IAL accounting theory > analysis of accounting statements > Flashcards

analysis of accounting statements Flashcards

ratio

1
Q

Profitability

A

profitability ratio is to assess a business’s ability to generate earning as compared to its expenses
and other relevant costs incurred during a specific period of time

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2
Q

profitability ratios (6) MMSSRR

A
  • margin / gp margin to sales
  • markup / gp markup to sales
  • sales margin / net profit margin to sales
  • selling and distribution /net profit to expense
  • return on capital employed
  • rate of inventory turnover
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3
Q

markup % formula

A

gross profit / cost of sales *100

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4
Q

margin % formula

A

gross profit / revenue *100

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5
Q

sales margin % formula

A

poty / revenue *100

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6
Q

selling and distribution % formula

A

poty / expense *100

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7
Q

return on capital employed formula

A

poty / capital employed *100

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8
Q

rate of inventory turnover % formula

A

cos / average inventory *100

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9
Q

capital employed formulas (2)

A
  1. usually use, Total Assets - Current Liabilities
  2. long-term investment, Fixed Assets + Working Capital
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10
Q

Ways to increase/improve profitability of a business (4)

A

 By increasing sales.
 By reducing cost of goods sold.
 By reducing expense.
 Advertising campaign boost up sales

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11
Q

Liquidity

A

Liquidity is the ability to meet short term (1) debts as they fall due (1)
Current assets less current liabilities (1) AO1

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12
Q

Ways to improve liquidity (4)

A

 By investing more into other business which shows the proper utilization of liquid cash.
 by selling existing fixed assets which are under-utilized.
 by injecting more capital from personal funds.
 improving rate of stock turnover. Rate of stock turnover can = by increasing sales and reducing the purchase of stock at the same time within a given time

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13
Q

high liquidity when?

A

(working capital ratio 5:1

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14
Q

Disadvantage of high liquidity (2)

A

 High closing stock which indicates unpopular goods for the business in market, also increase the warehouse
expenses.
 High debtors which increase the chance of risk of bad debt.

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15
Q

Benefits of ratio analysis (5)

A
  • They provide a basis for comparing performance year on year.
  • It enables comparison to be made with competitors.
  • Ratios is needed to forecast future performance.
  • They will focus on management attention on key areas such as profitability and liquidity.
  • It is useful for external users of financial information
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16
Q

limitations of ratio analysis (4)

A
  • do not consider non-financial factors such as social and ethical issues.
  • High skills are required for the analysis and evaluation of ratios correctly.
  • Ratios use historic data which may not reflect the future performance.
  • Different businesses may use different accounting policies when calculating ratios
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17
Q

margin %

A

gross profit margin to sales, gross profit every $100

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18
Q

markup %

A

gross profit markup to sales, gross profit to the cost of the sales

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19
Q

sales margin %

A

net profit for every $100 in sales

20
Q

selling and distributing %

A

net profit margin to sales, net profit for every $100 in sales

21
Q

return on capital employed

A

net profit made for every $100 employed

22
Q

rate of inventory turnover + ideal ratio

A

how efficiently a business manages its inventory, sales compared to inventory

2:1

23
Q

liquidity ratios (4)

A
  • current ratio / working capital
  • liquid acid test / quick ratio
  • debtors and creditors collection period
24
Q

current ratio formula

A

current assets / current liabilities

25
Q

standard current ratio

A

2:1

26
Q

current ratio use

A

general measure of a company’s ability to pay short-term obligations (due within a year)

27
Q

acid test ratio formula

A

current assets - closing inv / current liabilities

28
Q

acid test ratio standard

A

1:1

29
Q

acid test use

A

measure of liquidity that excludes slow-to-sell inventory from current assets, only current assets that are cash or can be quickly changed to cash, shows sufficient highly liquid assets to cover its short-term liabilities

30
Q

debtors and creditors collection period formula

A

debtors / creditors (÷) credit sales/ purchase * 365 days / 12 months

31
Q

debtors and creditors collection period use

A

Measures how long it takes a company to collect cash from customers (debtors) and how long it pays its suppliers (creditors).

32
Q

standard tr dr payment receiving period

A

28 days

33
Q

what does Lower Debtors Collection Period show

A

Indicates faster cash flow from sales.

34
Q

what is trade receivable

A

amount owed to a business

35
Q

what is Trade Receivable Collection Period

A

measures the average time it takes a company to collect payment from customers after a sale is made

36
Q

disadvantage of trade receivable collection period increasing (2(

A
  • When trade receivables increase, it means there’s a larger amount of due customer invoices. This translates to a longer period for the company to collect all that money.
    -will require credit control.
37
Q

credit control policies (2)

A
  • Monitoring outstanding invoices, sending payment reminders, and following up on overdue accounts.
  • Establishing clear guidelines for extending credit
38
Q

what does Shorter Creditors Payment Period show

A

May strain relationships with suppliers, but can improve cash flow in the short term.

39
Q

ideal debtors and creditors collection period

A

the debtors collection period should be shorter than the creditor payment period to ensure a positive cash flow cycle.

40
Q

How to improve rate of stock turnover

A

Rate of stock turnover can be improved by increasing sales and reducing the purchase of stock at the same time
within a given time.

41
Q

how to interpret profitability ratios

A

Higher ratios generally indicate better profitability

42
Q

how to interpret liquidity ratios

A

A current ratio above 1 and an acid-test ratio above 1 are generally good signs of liquidity

43
Q

bank balance and liquidity

A
  • if bank balance positive (dr) good.
  • consider the amount of bank balance tho, as small values may make payment difficult
44
Q

use of ratios to make future financial predictions

A
45
Q

how to write ratio analysis answers (3)

A
  • First compare profitability
  • compare liquidity using figures
  • Given overall discussion based on your profitability and liquidity which one is better (strong
    reasons are recommended for your justification).

Edexcel IAL accounting theory (5 decks)

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