financial statement analysis Flashcards
explain the term liquidity
liquidity is the ability of the business to repay its current liabilities when they fall due
working capital formula (liquidity)
total CA - total CL
current ratio (liquidity)
total CA/total CL
current ratio (liquidity)
total CA/total CL
quick ratio (liquidity)
total CA- inv- prepayments/total CL
suggest two measures __ may take to improve its cash flow position
1- sell excess non-current assets for cash
2- obtain additional bank loan
importance of liquidity
when a business does not have sufficient cash to pay for goods or services, suppliers are not willing to sell goods or services to the business and the business has no goods or services to offer to customers.
explain one problem faced by the business if they have insufficient working capital
1- insufficient cash to pay for daily operating expenses, for example, rent, utilities and wages
2- unable to take advantage of cash discounts because business is unable to pay promptly.
analysis for working capital
this means that the business has $___ of excess current assets after paying off the short-term debts of the business (hence, the business can use this amount for its day to day operating expenses)
analysis for current ratio
this means that the business has $__ of current assets to support every $1 of current liabilities that it owes
analysis of quick ratio
this means the business has $___ of quick assets to support every dollar of its immediate debt
liquidity worsening because?
1- worsening inventory position from one year to another (inventory value increase)
2- cash at bank/cash in hand value decreases
3- Trade payables ($24 300) is worse than ($11 200), and so the higher trade payables will add on to its financial burden in the short-term.
define profitability
measures the ability of the business to generate excess income to cover its expenses
suggest ways to improve the profitability of the business
1- sell goods at a higher selling price
2- the business could cut down on unnecessary expenses to improve profitability eg move to a smaller shop with the similar human traffic with cheaper rent
3- find ways to increase its other income to increase its profitability eg it can sublet part of the shop space to earn rental income
explain the importance of profitability
1- measures ability to continue operating and sustain the business in the long term
2- measures ability to reward employees and retain them to continue working for the business
explain the difference between profitability and liquidity
profitability refers to the business’ ability to generate excess income to cover up its expenses while liquidity refers to the ability of the business to repay its current liabilities when they fall due
explain how a profitable business may not be liquid
1- it may have difficulty in collecting payment from its credit customers
2- it may have excessively prepaid for their expenses
formula for mark up on cost
gross profit/cost of sales x 100
formula for gross profit margin
gross profit/net sales revenue x100 (%)
formula for profit margin
profit for the period/net sales revenue x 100 (%)
formula for return on equity
profit for the period/avg equity x100 (%)
analysis for mark up on cost
this means that the business earns ___ cents of gross profit for every dollar of cost of sale that it incurs
gross profit margin analysis
this means that the business earns ___ cents of gross profit for every dollar of net sales revenue earned
profit margin
this means that the business earns ___ cents of profit for every dollar of net sales revenue earned
return on equity analysis
this means that the business earns ___ cents of profit for every dollar of capital contributed by the owner
reasons for worsening and improving profitability
1- not managing its expenses as well as___
2- able to set a higher selling price on its products or able to purchase its goods at lower cost price
what is inventory management
inventory management is about deciding the amount of inventory that the business should have. it should not buy too much or too little inventory. business needs to maintain inventory at an optimal level to meet customer demand
consequences of having a low rate of inventory turnover
1- inventory could become obsolete and business my incur losses
2- cash would be tied up in inventory instead of being used in more profitable areas
3- business may incur additional storage cost to store the inventory
ways in which rate of inventory turnover can be improved
1- provide trade discounts to customers to encourage them to buy in bulk and regularly
2- attract more customers through marketing campaigns
ways in which days sales
in inventory can be improves
1- offer trade discounts to cut down selling price so as to encourage customers to buy the goods so as to clear stock and improve inventory turnover rate
2- do sales promotions
rate of inventory turnover formula
cost of sales/ avg inventory (times)
rate of inventory turnover analysis
this means that the business was able to sell and replenish its inventory ___ times in the accounting year
days sales in inventory formula
avg inv/ cost of sales x 365 days (days)
days sales in inventory analysis
this means the business took ___ days to sell its inventory in that accounting year
ways to improve efficiency in trade receivables management
1- monitor collection patterns closely
2- offer cash discounts to encourage early payment by credit customers
3- grant credit only to customers who are financially stable
rate of trade receivables turnover formula
net credit sales revenue/ average net trade receivables (times)
rate of TR turnover analysis
this means that the business collects approximately ___ times of payments from TR in an accounting year
trade receivables collection period formula
avg net TR/ net credit sales rev x 365 days (days)
trade receivables collection period analysis
this means that the business spends approximately ___ days in an accounting year to collect payment from its credit customers
reason for worsening of rate of inventory turnover
increased inventory holdings which can be seen from the worsening inventory balance from $50000 at 2021 to $60000 in 2022
