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FINANCIAL STABILITY
Analysis and Interpretation

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HEADING ONE
HEADING TWO

Analysis of Accounts

Financial stability refers to the short-term liquidity and long-term solvency of a business.

Liquidity Ratios
Working Capital (OR Current)
Acid Test (OR Quick)

Working Capital Ratio (OR Current Ratio)

Current Assets
Current Liabilities

75000/35500 = 2.1:1

Analysis of Accounts

The current ratio measures the business’s ability to pay its current liabilities using its current assets, ie short-term financial obligations.
Usually a ratio of 2:1 is acceptable.

High ratio:
High degree of assurance that current liabilities can be paid out of current assets

Low ratio:
Low degree of assurance that current liabilities can be paid out the current assets
Analysis of Accounts

Acid Test Ratio (OR Quick Ratio)

Current Assets – (Inventory + Prepayments)
Current Liabilities – Bank Overdraft

75000 – 25000 / 35500 = 1.4:1

Analysis of Accounts

The acid test ratio measures a business’s ability to meet its immediate financial obligations, such as accounts payable, from its immediately accessible or quickly converted assets such as cash and accounts receivable without selling inventory. Usually a ratio of 1:1 is acceptable.

High ratio:
High degree of assurance that current liabilities can be paid out of current assets

Low ratio:
The business is depending on inventory turnover to pay current debts (short-term liabilities)
Analysis of Accounts

Debt Ratio

Total Liabilities x 100
Total Assets

95600 x 100 = 60.5%

Analysis of Accounts

The debt ratio indicates the way in which the business is financed and the extent of the business’s borrowings in relation to its assets. It shows a business’s ability to pay off its liabilities using its assets.

High ratio:
assets generally being funded from borrowing

Low ratio:
assets generally being funded by the owners

Analysis of Accounts

Equity Ratio

Total Owners Equity x 100
Total Assets

62400 x 100 = 39.5%

Analysis of Accounts

The equity ratio indicates the extent to which the owner has financed the business’s assets as opposed to using borrowings.

High ratio:
most funds are being provided by the owner

Low ratio:
most funds are being provided by borrowings

Analysis of Accounts

When making decisions based on the ratios and percentages, certain processes should be followed.

Business experience and industry knowledge assist accountants to make meaningful recommendations.

Decision Making From Ratios

Calculate the ratios.

Scan the list of ratios and note any areas of concern.

Look for possible explanations (eg sales increased due to increase in advertising; or sales decreased due to current economic climate).

Draw attention to areas that may need additional information, such as making a comparison with similar businesses in the industry.

Make recommendations based on the above findings.

Decision Making From Ratios

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