Chapter 26 - Analysis Of Accounts Flashcards
Current assets (3)
Inventory/trading stock
Cash/cash equivalents
Debtors/account/trade receivables
Current liabilities (3)
Overdraft
Creditors/trade/account payables
Short term loans
Why does the acid test ratio remove inventory
Inventories/trading stock may take longer to sell and turn into cash
Capital employed
Shareholders’ equity plus non-current liabilities and is the total long-term and permanent capital invested in a business
Liquidity
The ability of a business to pay back its short-term debts
Profitability
The measurement of the profit made relative to either the value of sales achieved or capital invested in the business
Who profitability is important to
Investors when deciding which business to invest in
Directors + managers to assess the success of the business
Profitability ratios (3)
Return on capital employed
Gross profit margin
Net profit margin
Return on capital employed formula
(Net profit/capital employed) x 100
Gross profit margin
(Gross profit / Revenue) x 100
Net profit margin
(Net profit / Revenue) x 100
Illiquid
Means that assets are not easily convertible to cash
Liquidity ratios (2)
Current ratio
Acid test
Current ratio
Current assets/current liabilities
If between 1.5 and 2 the business is safe, lower than 1 the business has a cash flow problem
Acid test ratio
(Current assets - inventories) / current liabilities
Ideally 1:1, if lower, the business should be concerned
Internal users of accounts (3)
Managers
Workers and trade unions
Shareholders
External users of accounts (4)
Banks
Government
Creditors
Other businesses
What managers use accounts for
To help them analyse and keep control over the performance of each product/division of the business and to aid in decision making.
What type of company is owned by shareholders
Limited companies
What shareholders use accounts for
To see how big of a profit or loss a company has made, assess the liquidity and decide if they want to buy shares.
What creditors use accounts for
To check the ability of the business to pay back its debts to them on time and deciding whether to supply on credit
What the government uses accounts for
To check the profit tax paid by the company as if the business makes a loss it’s bad for the governments control of the economy
What workers and trade unions use accounts for
To assess whether the future of the business is secure or not
Limitations of using accounts and ratio analysis (4)
Different companies use different accounting methods leading to different ratio results making comparisons difficult
Accounting data is affected by inflation making it misleading to compare data between years
Ratios are based on past accounting data and may not indicate how a business will perform in the future
External users only have access to published accounts which contain only the legally required data
