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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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