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McKeith and Collins, Financial Accounting & Reporting, 2ndeditionEssay Questions Chapter 131. What are the limitations of ratio analysis that are inherent in the accounting data being used?2. Explain how your approach to analysing a set of financial statements would differ if you were carrying out the analysis on behalf of: a)A prospective shareholderb)A bank manager who has been asked to put overdraft facilities in placec)A potential supplier of a significant quantity and value of goods on credit3. Why is a highly geared company viewed as being more risky in periods of profit fluctuation? Is it possible to make any generalizations regarding the level of gearing and the trend in profits?4. In calculating the acid test or quick ratio, inventories are excluded from current assets. What is the purpose of this and are there any other issues that should be taken into account in the calculation?5. Briefly explain the differences between the A-Score and Z-Score methods of predicting corporate failure.6. The following summarized common-size statements of financial position have been prepared for five different companies in different industries. In addition, the industries in which the five companies operate are as detailed below. You are required to state which company is represented by which common-size statement of financial position giving reasons for your answers.7. The following ratios have been calculated for two companies both of which deal in the same kind of goods in the same town. It is the policy of one of the companies (Company A) to cut its prices and go for volume whereas the other company (Company B) pays more attention to customer service and impressive shop layout. Ratio (1)Ratio (2)Current ratio1.8:13.5:1Inventory turnover13.54.6 timesAcid test1.2:11.1:1Gross profit margin20%30%Net profit margin5%6%
McKeith and Collins, Financial Accounting & Reporting, 2ndeditionWhich set of ratios belongs to each company? 8. Explain the difference between horizontal analysis and vertical analysis in relation to the interpretation of financial statement data.9. Determine the effect on working capital, the current ratio and the quick ratio (acid test) of each of the following transactions. Consider each transaction separately and state whether it causes an increase (I), or a decrease (D) or no change (N).10. Outline and discuss the limitations of ratio analysis in interpreting published financial statements of a company.