bkp_lv3_c08_ratio - Advanced Financial Accounting Chapter 8...

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Advanced Financial Accounting Chapter 8 – Accounting Ratios ngivansir@hotmail.com Page 1 of 14 Advanced Financial Accounting Chapter 8 – Accounting Ratios Why using Accounting Ratios? Since financial statements only summarise the economic performance and financial position of a company, all information about assts, liabilities and capital, revenue and expenses are raw data. Users of financial statements need ratios to analyze, interpret the meanings and to evaluate the performance of the company, comparing with the ratios of different years, and/or with other firms in the industry. There are many ratios that can be used, however, we can group them into four major classifications as: Short-term liquidity ratios and working capital Capital structure and use of assets Profitability ratios Investments ratios Short-term liquidity and working capital ratios To measure the ability of a company to pay off its short-term debts. 1. Current ratio s liabilitie Current assets Current This compares assets which will become liquid within approximately 12 months with liabilities which will be due for payment in the same period. High current ratio means that the company may have sufficient funds to meet its short-term liabilities. However, it is not the single interpretation because the amount of cash and timing of receipt and payment of cash is also important. Low current ratio means that the company may have liquidity problems (unable to pay off its short term liabilities). 2. Acid test ratio s liabilitie Current stock - assets Current This ratio is similar to the current ratio. High acid-test ratio means that the company has sufficient liquid funds to meet its short-term liabilities. However, same as the current ratio, the amount of cash and timing of receipt and payment of cash is also important. The difference of current and acid-test ratio is that the closing stock which is included in the former ratio is non-current in nature, it means that it is hard to be realize into cash immediately.
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Advanced Financial Accounting Chapter 8 – Accounting Ratios ngivansir@hotmail.com Page 2 of 14 3. Stockturn or rate of turnover (in times) stock Average sold goods of Cost This ratio measures the number of times stock is turned over within a period. The quicker we sell the stock, the more the profit we will make. High stock turnover means that the stock level is too small when compare with its sales. The company should pay more attention to the following matters: a) The term of firm sales contracts it concluded with the buyers; b) The reliability of suppliers of goods; c) The risk of insufficient stock to meet sales demand; d) The risk of damage of goodwill in case of unable to meet the sales contract terms; e) The risk of loss of customers to competitors in case of unable to meet the demand of customers. Low stock turnover means that the stock level is too large when compare with its
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This note was uploaded on 09/20/2008 for the course ACCT 300 taught by Professor Gift during the Spring '08 term at West Virginia Wesleyan College.

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bkp_lv3_c08_ratio - Advanced Financial Accounting Chapter 8...

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