Interpretation of accounts

Question 1

What is the role and purpose of ratio analysis

Answer 1

Performance of a company can be analysed over the past year
Year’s performance can be compared with other years and a business can see what trends have developed
Performance can be compared with similar companies
Aids management, shareholders and investors making financial decisions

Question 2

What are the limitations of Ratio Analysis

Answer 2

Does not show nature of the business and i’s target market
Does not show who the owners are management and the number of employees
Only concerned with past events and figures are quickly out of date
Do not take seasonal fluctuations into account
Businesses use different bases and therefore comparisons between them are not accurate

Question 3

Explain overtrading

Answer 3

Occurs when there is too little working capital (CA-CL) in comparison to a high volume of sales
One of main causes of liquidity problems in business
The company should put good credit control in place to overcome

Question 4

Explain solvency

Answer 4

A business is solvent hen it can pay all debts as they fall due
A company is solvent if total assets are greater than it’s outside liabilities
Good indicator of company’s ability to survive

Question 5

How can a company overcome a liquidity problem?

Answer 5

Sell investments
Issue more shares
Borrow long term
Use sale and leaseback of fixed assets
Allow less trade credit to debtors and reduce their credit time period
Improved gross profit percentage- reduce COS or by passing on increased costs

Question 6

What can cause a decline in the rate of fixed asset turnover?

Answer 6

Fixed Asset turnover= Sales/Fixed Assets
Fall may be caused by not utilising the fixed assets properly e.g:size of the plant may be too big for the volume of sales

Question 7

What can cause a decline in the rate of current asset turnover?

Answer 7

Current Asset Turnover=Sales/Current Assets
CA Turnover= Sales/Current Assets
Decline caused by problem with CA or Sales e.g: Sales may fall without corresponding decrease in working capital. (ie. stocks may be building up or debtors increasing)

Question 8

Reasons for gross profit percentage falling?

Answer 8

COS increase by no corresponding increase in selling price
Theft of stock- Closing stock falls
Theft of cash- Cash sales figure falls
Reduced selling price but not corresponding COS decrease
Bad decision making- buying stock that cannot be sold for profit
More competition- drop in sales

Question 9

How can business correct a falling gross profit percentage?

Answer 9

Stock take regularly to detect theft
Watch cash tills closely
Sell more high profit product less low profit product
Include increase in the COS in the selling price
Buy stock that can be sold at profit

Question 10

How can business correct a falling net profit percentage?

Answer 10

Eliminate unnecessary expenses and cut down on others
Tighter controls of stock and cash
Increase the selling price or volume of sales
Buy less slow moving stock
Check on efficiency of sales department

Question 11

What are the heading to discuss would the shareholders be happy or would you advise someone to buy shares

Answer 11

Profitability
Liquidity
Share Price
Dividend policy
Gearing
(Investments)
Sector
Conclusion

Question 12

What are the heading to discuss would the debenture holders be happy?

Answer 12

Profitability
Liquidity
(Share Price)
Dividend policy
Gearing
Security
Sector
Conclusion

Question 13

What are the heading to discuss advising the bank manager

Answer 13

Profitability
Liquidity
Purpose of the loan
Dividend policy
Gearing
Security 
Sector
Conclusion

Question 14

To include when discussing if the shareholders would be happy under profitability

Answer 14

State ROCE decrease/increase.. profitable or not?
Higher/lower than return on risk free investments 1-2%
Rewards shareholders sufficiently for taking the risk?
Increasing/decreasing trend shows more/less efficient use of resources by management
Btter or worse than rate of interest debentures
Gross Profit percentage?
Shareholders will(not) be pleased with these returns

Question 15

To include when discussing if the debenture holders would be happy under profitability

Answer 15

State ROCE decrease/increase.. profitable or not?
Higher/lower than return on risk free investments 1-2%
The trend is (not) satisfactory and there is risk of having to sell fixed assets to repay debenture (or not)
Increasing/decreasing trend shows more/less efficient use of resources by management
Higher/lower than rate of interest on existing loan
Shareholders will(not) be pleased with these returns

Question 16

To include when discussing advice to bank manager under profitability

Answer 16

State ROCE decrease/increase.. profitable or not?
Higher/lower than return on risk free investments 1-2%
The trend is ( or not) satisfactory.
Increasing/decreasing trend shows more/less efficient use of resources by management since last year
Higher/lower than rate of interest on existing loan.
Higher or lower than cost of borrowing from bank
If loan was granted ROCE changes to…. and this will/will not be acceptable by bank

Question 17

To Include When discussing would the debentures be happy under liquidity

Answer 17

State acid test ratio
Discuss bad/good trend. Is liquid or illiquid?
Above or below 1:1?
Shows firm has (not) got problem meeting short term debts and possible future interest charges as they fall due from Liquid assets.
For every €1 owed has – to meet these debts
If trend continues ability to pay interest would (not) come under pressure- not available to invest in repayment of loan, face potential bankruptcy?
Debenture holders happy?

Question 18

To include when discussing advice to bank manager under liquidity

Answer 18

State acid test ratio
Discuss bad/good trend. Is liquid or illiquid?
Above or below 1:1?
Shows firm has (not) got problem meeting short term debts as they fall due from Liquid assets.
For every €1 owed has – to meet these debts
If loan was granted company would (not) have problem paying interest of €X

Question 19

To include when discussing would shareholders be happy under liquidity

Answer 19

State acid test ratio
Discuss bad/good trend. Is liquid or illiquid?
Above or below 1:1?
Shows firm has (not) got problem meeting short term debts and possible future dividends as they fall due from Liquid assets.
No problem/problem giving dividend
For every €1 owed has – to meet these debts
Shareholders pleased or not?

Question 20

To include when discussing would shareholders be happy under Share Price

Answer 20

State market price improvement/fall
Indicates growing/falling stock market confidence in company
State Price Earning Ratio- shows longer/shorter for shareholder to recover investment
Pleased or not if they seek quick return on investment
By purchasing X shares shareholder will own X%
Offer price is low- investor needs to be cautious and question why shares are available at reduced price

Question 21

To include when discussing would debenture holders be happy under Share Price

Answer 21

State market price improvement/fall

Indicates growing/falling stock market confidence in company

Question 22

To include when discussing would shareholders be happy under dividend policy

Answer 22

State DPS and D yield- is this above/below return on risk free investments (1-2%)?
Dividend cover comparison?
Shareholders happy or not with (dis)improving trends
Shareholders may be happy with improving trends by feel there is scope for higher dividends or pleased more profit are being retained for future expansion or repayment of debenture/ would like to see more profit being retained for expansion purposes

Question 23

To include when discussing would debenture holders be happy under dividend policy

Answer 23

State DPS and D yield- is this above/below return on risk free investments?
Dividend cover comparison?
The % profits given out has improved/disimproved from - to -
Debenture holders prefer to see profits retained

Question 24

To include when discussing advice to bank manager under dividend policy

Answer 24

D yield- is this above/below return on risk free investments?
Dividend cover comparison?
Indicates sufficient/insufficient profits retained
High retention of profit ensure new loan is more easily repaid
Low retention of profits hinders repayment

Question 25

To include when discussing would shareholders be happy under gearing

Answer 25

State gearing ratio- high/low geared?
Less/more dependent on outside borrowing and is not/is at risk from outside investors?
Please shareholders?- increase or not chance of dividend
Interest cover state?
Firm will (not) have problem paying interest charges

Question 26

To include when discussing would debenture holders be happy under gearing?

Answer 26

State gearing ratio- high/low geared?
Less/more dependent on outside borrowing and is not/is at risk from outside investors?
Higher the gearing more at risk is the interest payment
Please debenture holders? Is it lowly geared?
Interest cover state?
Firm will (not) have problem paying interest charges

Question 27

To include when discussing advice to the bank manager under gearing?

Answer 27

State gearing ratio- high/low geared?
What would gearing be with additional loan (financed by more debt than equity perhaps?)
Less/more dependent on outside borrowing and is not/is at risk from outside investors?
Interest cover state?
Interest cover change after loan
Firm will (not) have problem paying interest charges of X

Question 28

To include when discussing would the shareholders be happy under investments

Answer 28

Investments by company cost X
Now have market value of X
Indicates good/poor management of resources by firm
When sold will result in gain/loss of X

Question 29

What to include in sector?

Answer 29

State sector
Growth area or decline? Prospects and competition?
Potential for future profits or not?
Long term rpospects and short term proscpects

Question 30

To include when discussing would debenture holders be happy under security?

Answer 30

Debentures are secured against fixed assets
Fixed assets worth X, debenture worth X. Would be prudent to ascertain the real value of FA as there is no write off for depreciation
Investments cost X and are now Y- Debenture holders not happy as shows poor management of investments
Intangible assets are X- holders need to know what they are ex: Patents
Debenture holders feel secure or not as the excess in the value of FA over the amount of loan

Question 31

To include when discussing advice to manager under security?

Answer 31

Fixed assets worth X
Would be prudent to ascertain the real value of FA as there is no write off for depreciation
Already XXXXXX committed to securing existing debenture
Investment cost vs worth
Security for new bank loan is (not) adequate

Question 32

To include when discussing advice to the bank manager under purpose of loan

Answer 32

Loan required for X
Make more competitive
Extra production means extra income and profits to repay loan