Exam revision questions Flashcards
Return on assets
Return on assets measures the overall net profit as a percentage of average total assets invested in the firm. It represents a company’s ability to generate profits from its entire assets base, not just those resources provided by owners. It reflects its profitability from revenue and profitability from investments in assets.
For example, GASKA Ltd.Ltd ROA ratio of 32,75% shows that GASKA Ltd.Ltd generated approximately 33 cents in profit for every dollar of assets it possessed during the
year.
Net Profit Margin
Net Profit margin measures the percentage of each sales dollar that represents net profit. A higher ratio indicates a greater ability to generate profits from sales.
For example, GASKA Ltd.Ltd’s net profit margin is 22.9%, which means that the company generated 22.9 cents net profit from each sales dollar.
Asset turnover
Asset turnover measures how efficiently an entity uses its assets to generate sales. So, higher ratio is always favourable.
For example, the asset turnover ratio of GASKA Ltd.shows that the company generated $1.40 sales for every dollar invested in its assets.
Relationship between ROA, NPM and AT
The ratios are interrelated as profit margin multiplied by asset turnover gives return on assets.
For example, for GASKA Ltd.., the profit margin of 22.9% multiplied by the asset turnover of 1.43 times = return on assets of 32.75%.
Describe what this information indicates about the differences in each business approach
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Companies can follow many different business strategies to success. One strategy is to sell many products at low prices and rely on high sales volume to create profits. It seems Blackjacks Ltd. follows this strategy. The other possible strategy is to keep higher profit margin to compensate for low sales turnover. It seems GASKA Ltd. follows this strategy by having lower asset turnover but higher profit margin than Blackjacks Ltd.
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Q5
The current ratio and the accounts receivable turnover have improved during the last three years. However, company’s quick assets ratio has declined significantly. This could cause major liquidity issues as they may not be able to settle their bills when they become due.
It appears that the slow-moving inventory brings major liquidity crisis to the business.
You are reviewing the performance of a company that has posted its most recent year-end financial statements a rate of return of 10%
Discuss additional information and bench marks that might assist you in evaluating
whether this return is adequate
A single ratio by itself may not be very meaningful and is best interpreted by comparison with: (1) past ratios of the same entity, (2) ratios of other entities, or (3) industry norms or predetermined standards. In addition, other ratios of the entity such as efficiency, liquidity and gearing ratios are necessary to determine overall financial well-being.
Explain the main difference between a provision and a contingent liability
Provisions satisfy the definition of a liability and are defined as liabilities for which only the amount or timing of the future sacrifice of economic resources is uncertain. Nevertheless, they are recognised as liabilities.
A contingency, on the other hand, is a liability (or indeed, an asset) whose outcome will be confirmed on the occurrence or non-occurrence of future uncertain events beyond the control of the entity. Such a contingency may or may not satisfy the recognition criteria for a liability. As such, it may or may not be reported on the balance sheet. However, contingencies have been reported in notes to annual reports. A contingent liability is a liability but is one that does not satisfy the recognition criteria for a liability because it is not yet probable that a future sacrifice of resources will be required, or the amount cannot be measured reliably.
The accounting treatment for a provision and a contingent liability is the same. Discuss
The statement is not true.
A provision must be recognised as a liability and reported on the balance sheet. Provisions satisfy the definition of a liability and are defined as liabilities for which only the amount or timing of the future sacrifice of economic resources is uncertain. Nevertheless, they are recognised as liabilities.
A contingent liability is a liability but is one that does not satisfy the recognition criteria for a liability because it is not yet probable that a future sacrifice of resources will be required, or the amount cannot be measured reliably. IAS 37/AASB137 states that contingent liabilities are not to be included in the
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