U2- Ratios

Question 1

What does the liquidity ratio consist of?

Answer 1

Current ratio

Acid test ratio

Question 2

Describe the current ratio

Answer 2

Used to indicate the business’s ability to meet its short term debts without having to borrow money

Where the ratio is low this indicates that the business may have problems in meeting its short term debts

Question 3

Describe the acid test ratio

Answer 3

Similar to the current ratio but takes into account the fact that inventories of raw materials and goods for resale may take some time to be turned into cash

The average figure of 1:1 should be used as a guideline however the typical ratio will depend on the type of business

Question 4

What do efficiency ratios consist of?

Answer 4

Rate of inventory turn over

Trade payables period

Trade receivables period

Question 5

Describe the rate of inventory turnover

Answer 5

This ratio measures the number of times that the inventory held by the company is turned over

The formula used to calculate inventory turn over is

Cost of sales/ average inventory

Question 6

Describe the trade payables period

Answer 6

This ratio measures the number of days (or weeks or months) it takes the business to pay its credit amounts

The formula used to calculate trade payables period is

Average trade payables/ credit purchases x 365

Question 7

Describe the trade receivables period

Answer 7

This ratio measures the number of days (weeks or months) it takes the business to receive money from its credit accounts

The formula used to calculate this is

Average trade receivables/ credit sales x 365

Question 8

Give 5 reasons for change in the accounting ratios

Answer 8

Gross profit ratio could decrease as:

There is more competition in the market

The selling price is reduced

Increased purchasing costs

It could increase as:

The business has a competitive advantage and can charge more than competitors

Question 9

Give 5 ways to improve the gross profit ratio

Answer 9

Increase sales price to increase revenue

Use cheaper suppliers

Negotiate better discounts from existing suppliers

Monitor theft and damage to inventory

Better management of inventory levels

Question 10

Give 4 ways to improve the current ratio

Answer 10

Limit the amount of credit used

Decrease current liabilities

Improve credit control

Increase the level of current assets