Term 3 - Analysis of Ratios

Question 1

Title

Answer 1

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

Question 2

Summary

Answer 2

_______ 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

Question 3

Introduction

Answer 3

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.

Question 4

Define Financial Stability

Answer 4

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

Question 5

Current Ratio Define

Answer 5

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

Question 6

Current Ratio Acceptable

Answer 6

2:1

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

Question 7

Current Ratio Analysis

Answer 7

Assets decreasing
Liabilities Increasing
Horizontal Analysis

Question 8

Current Ratio Strategies

Answer 8

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

Question 9

Current Ratio Recommendation

Answer 9

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.

Question 10

Quick Ratio Define

Answer 10

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

Question 11

Low Quick Ratio

Answer 11

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

Question 12

Quick Ratio Analysis

Answer 12

Current Assets decreasing
Current Liabilities Increasing
Horizontal Analysis

Question 13

Quick Ratio Strategies

Answer 13

• decrease current liabilities

- increase current assets

Question 14

Quick Ratio Reccomendation

Answer 14

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

Question 15

Equity Ratio Define

Answer 15

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

Question 16

Equity Ratio Analysis

Answer 16

Net Profit decreasing
Drawing Increasing
Vertical and Horizontal Analysis

Question 17

Equity Ratio Strategies

Answer 17

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

Question 18

Equity Ratio Recommendation

Answer 18

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

Question 19

Debt Ratio Define

Answer 19

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

Question 20

Debt Ratio Analysis

Answer 20

• Liabilities increasing
• Assets decreasing
• Verticle and Horizontal Analysis

Question 21

Debt Ratio Strategies

Answer 21

• 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

Question 22

Debt Ratio Recommendation

Answer 22

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

Question 23

Define profitability

Answer 23

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

Question 24

Gross Profit Define

Answer 24

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

Question 25

Gross Profit Analysis

Answer 25

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

Question 26

Gross Profit Strategies

Answer 26

- 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

Question 27

Gross Profit Recommendation

Answer 27

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

Question 28

Net Profit Define

Answer 28

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

Question 29

Net Profit Analysis

Answer 29

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

Question 30

Net Profit Strategies

Answer 30

Reduce Expenses | Increase Revenues

Question 31

Net Profit Recommendation

Answer 31

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

Question 32

Rate of Return on Equity Define

Answer 32

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

Question 33

Rate of Return OE Analysis

Answer 33

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

Question 34

Rate of Return OE Strategies

Answer 34

Decrease Capital or use it more effectively Increase Net Profit by increasing revenue or decreasing expenses

Question 35

Rate of Return on OE Recommendation

Answer 35

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.

Question 36

Rate of Return on Total Asset Define

Answer 36

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

Question 37

Rate of Return TA Analysis

Answer 37

Increase in Total Assets Decrease in Net Profit Horizontal Analysis

Question 38

Rate of Return TA Strategies

Answer 38

- Increase Net Profit - Decrease Average total Assets - Ensure assets are used effectively to generate profit

Question 39

Rate of Return on TA Recommendations

Answer 39

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

Question 40

Management Effectiveness Define

Answer 40

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

Question 41

Rate of Turnover of Inventories Define

Answer 41

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

Question 42

Rate of Turnover of Inventories Analysis

Answer 42

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

Question 43

Rate of Turnover of Inventories Strategies

Answer 43

- 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

Question 44

Rate of Turnover of Inventories Recommendations

Answer 44

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.

Question 45

Rate of Turnover of Accounts Receivable Define

Answer 45

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

Question 46

Rate of Turnover of Accounts Receivable Analysis

Answer 46

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.

Question 47

Rate of Turnover of Accounts Receivable Strategies

Answer 47

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

Question 48

Rate of Turnover of Accounts Receivable Recommendation

Answer 48

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.