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Accounting Yr 12 > Term 3 - Analysis of Ratios > Flashcards

Term 3 - Analysis of Ratios Flashcards

1
Q

Title

A

Evaluation of the Financial Position of ____________ as at 30 June 2017

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2
Q

Summary

A

_______ is/is not operating at an acceptable level. The business compares favourably with other business in the industry. However, in other areas the business’ performance is unfavorable and improvements need to be made. These areas will be addressed in this report

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3
Q

Introduction

A

Financial reports are one means of communicating information. The use of ratio financial stability, earning capacity and effectiveness of management policies ratios, greatly assist in the analysis and interpretation of financial reports. Each type of ratio will be addressed independently in this report.

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4
Q

Define Financial Stability

A

The Financial Stability ratios give an indication of the short term liquidity and the long term solvency of an enterprise

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5
Q

Current Ratio Define

A

The current ratio indicates the ability of an enterprise to meet its short term financial obligations

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6
Q

Current Ratio Acceptable

A

2:1

However, above 1:1 indicates it is able to meet its short term obligations

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7
Q

Current Ratio Analysis

A

Assets decreasing
Liabilities Increasing
Horizontal Analysis

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8
Q

Current Ratio Strategies

A
  • monitor and bring back to 2:1
  • decrease current liabilities
  • if appropriate renegotiate short term loans into long term.
  • increase current assets
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9
Q

Current Ratio Recommendation

A

Why Concern? Below the acceptable ratio and industry average

The current ratio should be monitored and steps taken to increase the ratio back to 2:1.

  • reducing the liabilities
  • renegotiate short term loans to long term
  • increasing the current assets

This will ensure the business can meet its short term financial obligations.

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10
Q

Quick Ratio Define

A

The quick ratio measures the ability of a business to meet its immediate financial obligations

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11
Q

Low Quick Ratio

A

The business is unable to meet its immediate financial obligations and is dependent on inventory turnover to pay its current liabilities

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12
Q

Quick Ratio Analysis

A

Current Assets decreasing
Current Liabilities Increasing
Horizontal Analysis

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13
Q

Quick Ratio Strategies

A
  • decrease current liabilities

- increase current assets

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14
Q

Quick Ratio Reccomendation

A

Why Concern? Unable to meet its immediate financial obligations

  • Decrease Accounts Payable
    • be mindful of the amount of credit purchase, buying
      goods when possible.
  • Increase current assets.

This will provide a high degree of assurances that the current liabilities can be paid out of current assets, allowing the business to meet its immediate financial obligations

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15
Q

Equity Ratio Define

A

The Equity Ratio indicates the extent to which the owner has financed the business’ assets, as opposed to using alternative sources of financing - borrowings.

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16
Q

Equity Ratio Analysis

A

Net Profit decreasing
Drawing Increasing
Vertical and Horizontal Analysis

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17
Q

Equity Ratio Strategies

A
  • decrease debt, _____ , through repayments
  • minimize the need to hold large assets
  • minimize the need to borrow beyond 50:50 balance of equity and debt
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18
Q

Equity Ratio Recommendation

A

Issue? The business is highly dependent on borrowings for financing

  • increase the amount invested/decrease drawings
  • decrease debt through repayments

This will mean that business is financed in the most effective manner

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19
Q

Debt Ratio Define

A

The Debt Ratio indicates the way in which the business is financed and the extent of the business’ borrowings in relation to assets.

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20
Q

Debt Ratio Analysis

A
  • Liabilities increasing
  • Assets decreasing
  • Verticle and Horizontal Analysis
21
Q

Debt Ratio Strategies

A
  • Decrease debt, __________, through regular repayments, reducing the interest on debt
  • Minimize the need to hold large assets, meaning the business will not need to borrow to finance these purchases.
  • Do not borrow beyond 50% debt equity
22
Q

Debt Ratio Recommendation

A

Why issue? Highly dependent on external sources for financing

  • decrease their debt ______ through repayments

This will mean that business is financed in the most effective manner

23
Q

Define profitability

A

Profitability is the ability to earn income within the current financial structure of an enterprise

24
Q

Gross Profit Define

A

The gross profit ratio indicates the ability of a trading enterprise to generate gross profit from sales

25
Q

Gross Profit Analysis

A

Increase in Cost of Goods Sold
Decrease in Net Sales
Vertical and Horizontal Analysis

26
Q

Gross Profit Strategies

A
  • Reduce Cost of Goods Sold
    - Find a cheaper supplier - spend less on goods
    and retain the same revenue on sales
  • Increase Net Sales
    - Increase selling price
27
Q

Gross Profit Recommendation

A

Why?- Below industry average

  • reduce cost of goods sold
  • increase net sales

This will allow the business to increase their gross profit and easily cover all of their expenses and have the capacity to earn an acceptable net profit and return on investment

28
Q

Net Profit Define

A

The purpose of Net Profit is to show the ability of the business to generate a return on the owner’s investment.

29
Q

Net Profit Analysis

A

Gross Profit High or Low
Increase in Expenses - Too high when compared to sales
Decrease in Revenues - low selling margin
Vertical and Horizontal Analysis

30
Q

Net Profit Strategies

A

Reduce Expenses

Increase Revenues

31
Q

Net Profit Recommendation

A

Issue? Below industry average

  • monitor expenses and implement strategies to decrease
  • Increase revenues

A higher operating revenue and low operating expenses will result in a high net profit. This will mean that the owner will receive a higher return on equity

32
Q

Rate of Return on Equity Define

A

The rate of return on Owners Equity indicates the return on the owner’s investment in the business

This is good/bad compared to the return the owner would have recieved if invested in other financial institutions

33
Q

Rate of Return OE Analysis

A

Decrease in Net Profit
Increase in /Too Much Capital
Horizontal Analysis

34
Q

Rate of Return OE Strategies

A

Decrease Capital or use it more effectively

Increase Net Profit by increasing revenue or decreasing expenses

35
Q

Rate of Return on OE Recommendation

A

Issue? - Below industry Average, may suggest it would be more beneficial for the owner to invest elsewhere

  • increase net profit
  • Decrease capital

This will mean that the Owner’s return on equity will increase.

36
Q

Rate of Return on Total Asset Define

A

The rate of return on total assets ratio indicates the ability of the enterprise to generate profit using their assets.

37
Q

Rate of Return TA Analysis

A

Increase in Total Assets
Decrease in Net Profit
Horizontal Analysis

38
Q

Rate of Return TA Strategies

A
  • Increase Net Profit
  • Decrease Average total Assets
  • Ensure assets are used effectively to generate profit
39
Q

Rate of Return on TA Recommendations

A

Why Issue? Poor performance of assets in generating profit

  • increase net profit
  • consider selling assets such as _____ which are proving ineffective in generating profit
  • ensure assets are being used to their full capacity

The implementation of these recommendation will ensure the effective use of assets to generate profit

40
Q

Management Effectiveness Define

A

Effectiveness of management policies is the measurement of how proficient managers have been in directing and maintaining set policies

41
Q

Rate of Turnover of Inventories Define

A

The rate of turnover of inventories ratio measures how efficiently the inventory of the business is being managed

42
Q

Rate of Turnover of Inventories Analysis

A

The business has a large holding of slow moving inventory indicated by the high inventory control when compared to the cost of goods sold

43
Q

Rate of Turnover of Inventories Strategies

A
  • sell more inventory
    - target customers through advertising and 
reassessment of business' pricing policy

- phase out stock that is not moving quickly and 
ensure a steady supply of popular inventory
44
Q

Rate of Turnover of Inventories Recommendations

A

Why Issue? Poor compared to industry

  • Targeted advertising
  • reassessment of pricing policy
  • phasing out stock that doesn’t move quickly and have a steady supply of stock that does

Implementing these recommendations will ensure that the business be selling more stock and therefore has a greater chance of generating profit.

45
Q

Rate of Turnover of Accounts Receivable Define

A

The rate of turnover of accounts receivable measures the efficiency of the business in managing its accounts receivable

A variation with 10-15 days of company policy is acceptable

46
Q

Rate of Turnover of Accounts Receivable Analysis

A

The poor turnover of accounts receivable can be attributed to a loose credit policy. This has resulted in a low amount of accounts receivable when compared to net credit sales and a significant amount of bad debts.

47
Q

Rate of Turnover of Accounts Receivable Strategies

A

Tighten Credit Policy
- following up on late payers via phone, email or letter
- offering discount for early cash payments
- effective screening of customers prior to providing
credit

48
Q

Rate of Turnover of Accounts Receivable Recommendation

A

Concern? High number of bad debts.

Immediate attention should be given to debt collection.
Tighten credit policy
- Follow up on late payers
- offer discounts for early cash payments
- effective screening of customers prior to providing them with credit

The adoption of these recommendations will decrease the rate of turnover of accounts receivable, improving the average payment time and reducing the amount of bad debts. This will result in a greater profit for the business.

Accounting Yr 12 (10 decks)

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