Ratios

Question 1

Identify FOUR users of the Financial Statements.

Answer 1

1. Shareholders and prospective shareholders: dividends, profitability, (and the market hare value which is not in financial statements)
2. Trade Payables: Liquidity
3. Banks and Lenders: the
   company’s ability to repay its debts (capital structure)
4. Tax Department (Govt.): profitability to collect taxes
5. Employees: job security and negotiations for pay increase (trade unions)
6. Managers: profitability

Question 2

Describe FOUR qualitative
characteristics that the information included in financial statements should have.

Answer 2

Four principle characteristics:

1. Relevance: showing the right information
2. Faithful representation: this is important so that users can compare and make correct decisions
3. Comparability: to compare with previous years or with similar firms
4. Understandability: simple and easy to understand
5. Verifiability
6. Timeliness

Question 3

Distinguish between profitability and liquidity

Answer 3

Profitability: asses the company’s performance based on profits. This is the degree to which a company yields profit or financial gain. This can be seen in the SOPL.

Liquidity: the amount of cash and cash to come a company can put its hands on quickly to settle its debts. The short-term financial position of a business.

Question 4

Describe TWO ratios that can be used to measure the profitability of a company.

Answer 4

1. ROCE: the primary profitability ratio and the main indicator of performance and profitability. It measures the return generated by the business. It is calculated using = (PBIT / Capital Employed x 100)
2. Gross Profit Margin: a secondary profitability ratio. It helps us analyse and evaluate the business performance, and gives an indication of the pricing system. It is calculated using = GP / Sales x 100.

Question 5

Describe TWO ratios that can be used to measure the liquidity of a company.

Answer 5

1. Current Ratio = CA / CL
2. Quick Ratio (acid ratio) = (CA - Inventory) / CL

These help to assess if the company as enough current assets to pay its current liabilities. They asses the company’s ability to remain solvent and its current cash position to honour the short term debts.

Question 6

Describe TWO sources of long-term borrowing. Provide advantages and disadvantages.

Answer 6

Long-term loans are taken from a bank, for a prolonged period to suit the borrower’s convenience and capability to repay the loan amount.
They have manageable repayment terms due to lower interest rates. However, in the long run, it ends up being more expensive overall, especially in periods of deflation.

Debentures are a long-term security yielding a fixed rate of interest, issued by a company and secured against assets. They are used by large companies to borrow money.
The use of debentures can encourage long-term funding to grow the business, but there is no flexibility in the company’s obligation to make interest payments. This can force insolvency in some cases.

Question 7

Mention 2 Efficiency Ratios.

Answer 7

1. Rate of Inventory Turnover.
2. Trade Receivables’ Ratio.

Question 8

What is the Rate of Inventory Turnover?

Answer 8

Rate of Inventory Turnover = Cost of Sales / Average Inventory.

This helps to indicate a slowdown in trading or a build-up in stock levels, perhaps suggesting that investment in stocks is becoming excessive.

Question 9

What is the Trade Receivables’ Ratio?

Answer 9

Trade Receivables’ Ratio = (Debtors / Sales) x 365 days

It is a rough measure of the average length of time it takes for a company’s debtors to pay. If debtor days are increasing year on year, it reflects poor management credit control.