Unit 4 Acc Chp 18 & 19 Profitability & Liquidity VCAA Q

Question 1

2008 E2 1.5.2 insert pic
Explain how the trend in Creditors Turnover in term of its impact on CASH FLOW (CTO was budgeted to be higher aka take longer to pay creditors)

Answer 1

Cash flow - business is taking longer repay its creditors. They are holding onto their cash longer. This is a positive impact on the cash flow of business

Question 2

2008 E2 1.5.2 insert pic
Explain how the trend in Creditors Turnover in term of its impact on profitability (CTO was budgeted to be higher aka take longer to pay creditors)

Answer 2

By taking longer to pay creditors, the business is not taking advantage of discounts offered, thus lowering revenue & profit

Question 3

2008 E2 Insert pic
Identify & explain with ref to Debtors & Stock turnover, whether the efficiency of the business is expected to :
- improve/deteriorate/remain unchanged/ unable to be determined
(DTO& STO were budgeted to become faster aka have lower by,bee of days)

Answer 3

Both ratios are expected to improve (reduction in number of days) then the business can expect cash to be received more quickly from debtors and stock to be turned into sales, and therefore cash at a faster rate

Question 4

2007 E2 2.6.1 - insert pic

Explain what is meant by the term ‘liquidity’

Answer 4

The ability of the business to meet its short term debts/financial commitments when they fall due. The more ‘liquid’ a business is, the more able it is too meet short term commitments

Question 5

2007 E2 2.6.2 insert pic
Explain how the trend in Debtor’s turnover can have a negative effect in liquidity (it was worse in current year aka the days was higher than previous)

Answer 5

Cash from debtors are being received at a slower rate, which means that the business may have difficulty purchasing stock and paying creditors and expenses. This can result in the business having to go into overdraft or taking out a short term loan to pay for these items.

Question 6

2007 E2 2.6.3

State 2 new strategies that could be implemented to improve Debtor’s turnover

Answer 6

Any of :

• reduce credit terms to 14 days or reduce in general
• better screening of debtors (easy to remember)
• increase the discount allowed (saying give out discounts is not accepted. Must say increase the discount)
• follow up sales with reminder notices & phone calls
• insist on a deposit for large sales
• prepare a Debtors Ageing Analysis (???)

Question 7

2008 E2

Explain how Debtors turnover is used as a measure of efficiency

Answer 7

It indicates how well the business is in collecting debts from it’s credit customers & how well they manage their credit account. The lower the number of days, the more efficient the business is in managing its debtors

Question 8

2010 E2

Explain the difference between the concepts of Profit and Profitability

Answer 8

Profit under accrual accounting is revenues earned less expenses that is expressed as a dollar amount.

Profitability is a measure that compares the profit figure against a base such as total assets and examines how well a business has used its investment in assets

Question 9

2010 Q1.3.2

Explain how the Return on assets can increase while the asset turnover can decrease

Answer 9

ROA increases when NP ratio has increased at greater proportion than the decrease in ATO.

This may be achieved by better expense control or better GPM which would lead to an increase in NP

Question 10

2010 Q1.3.3
Accountant reported ROI was 12% for Dec 31 2011.
State 2 benchmarks other than trend analysis that could be used when evaluating whether this is satisfactory or not

Answer 10

Industry averages for similar businesses

Budgeted goals

Question 11

2010 2.2.1

Explain what is meant by liquidity

Answer 11

The ability of the business to meet its short term financial commitments as they fall due.

Question 12

2010 2.2.2

Explain how it’s possible that WCR trend is favourable while QAR trend is unfavourable

Answer 12

Stock and prepayments are both included in the WCR but excluded in the QAR. An increase in stock levels may lead to a higher WCR without affecting the QAR

Question 13

2010 2.2.3
State 2 strategies excluding additional advertising, Perra could implement to improve STO (besides reduce STO days) without affecting GPM

Answer 13

Reduce average level of stock by discontinuing slow moving lines
- improve stock mix by concentrating on fast moving lines

Question 14

2010 2.2.4

Explain why CTO trend could be described as unfavourable

Answer 14

Cash is leaving the business earlier which could lead to further liquidity problems. This may occur as there is no discount gained for early payment & DTO is much longer than CTO. Therefore business may run out of cash & struggle to meet its future debts.

Question 15

2010 2.2.5

2 strategies to improve DTO

Answer 15

Improved follow up procedures when accounts are overdue
Tightening up credit approval procedures
refusing further credit to slow paying debtors

Question 16

2009 1.4

Explain how ROA can improve despite fall in GPM

Answer 16

Assets has been used more efficiently within the business which may have increased total sales.

Question 17

2009 1.4.2

2 reasons for fall in NP ratio

Answer 17

• Cost of sales increased at greater rate than selling price of stock.
• other expenses increases at greater rate than selling price of stock

Question 18

2009 1.4.3

Identify 2 other benchmarks to consider before making any decisions about profitability of the business

Answer 18

• Budget goals

- Industry averages

Question 19

2009 2.4.1

What is meant by liquidity

Answer 19

Business ability to meet its short term financial commitments as they fall due

Question 20

2009 2.4.2 insert pic
Discuss based on above indicators whether liquidity improved in 2009
(WCR, QAR, DTO, STO)

Answer 20

WCR has improved marginally but business still has difficulty to meet its debts on time.

DTO & STO have deteriorated, meaning it takes longer to convert assets into cash and worsen liquidity.

Increase in WCR& QAR are more likely to be caused by build up debtors and stock balances, and not improving liquidity

Question 21

2009 2.4.3

State one other key indicator that could be used when assessing business liquidity

Answer 21

Cash flow ratio

Interest cover ratio

Question 22

2014 Q3

Owner believes improving STO should increase GP. Do you agree & explain.

Answer 22

If stock levels are unchanged and Mark ups remain unchanged then an increase in STO will lead to increase in GP.
This is because more goods will be sold during the reporting period at the same profit margin, thus increasing in gross profit.

However if improve in STO is achieved by stock levels being decreased and sales volume remains unchanged, average mark up would need increase in order to increase gross profit.