2). There is no particular result that can be considered a universal and reliable guide to a firm’s liquidity. Many accountants recommend a result of around 1.5 – 2, but much depends on the industry the firm operates in and the recent trend in the current ratioThe Acid Test Ratio:The acid-test ratio (also known as the quick ratio) compares the current assets minus inventories (stocks) with the current liabilities of the businessAcid-test ratio = Current assets – Inventories (stocks)Current liabilities The acid-test ratio is a stricter test of a firm’s liquidity. It ignores the least liquid of the firm’s current assets – inventories (stocks). Inventories, by definition, have not yet been sold and there can be no certainty that they will be sold in the short term. By eliminating the value of inventories from the acid-test ratio, the users of accounts are given a clearer picture of the firm’s ability to pay short-term debts.
Calculate the current and acid-test ratio for Funny Company Limited. (4)
Calculate the current and acid-test ratio for Tricky Company Limited. (4)Evaluation of ways to increase liquidityMethod to increase liquidityExamplesEvaluation of methodSell off fixed assets for cash – could lease these back if still needed by the business Land and property could be sold to a leasing company If assets are sold quickly, they might not raise their true value If assets are still needed by the business, then leasing charges will add to overheads and reduce net profit margins
Method to increase liquidityExamplesEvaluation of methodSell off inventories for cash; this will improve the acid-test ratio, but not the current ratio Stocks of finished goods could be sold off at a discount to raise cash. JIT stock management will achieve this objective. This will reduce the gross profit margin if inventories are sold at a discount. Consumers may doubt the image of the brand if inventories are sold off cheaply. Inventories might be needed to meet changing customer demand levels – JIT might be difficult to adopt in some industries. Increase loans to inject cash into the business and increase working capital Long-term loans could be taken out if the bank is confident of the company’s prospects These will increase the gearing ratio These will increase interest costs McDonald’s: Ratio analysis Calculate McDonald’s gross and net profit margin at the end of 2011 Calculate McDonald’s current and acid-test ratio at the end of 2011.
Improving profitabilityMissing wordsProfit is the difference between total ___________________ and total costs. Improving profit can only be achieved by cutting ______________ or increasing _______________________. The problem is that neither is easy. In 2008 Marks and Spencer demanded that all its suppliers cut their prices by between 2% and 6%. The supplier of all its Italian ready meals (Lasagne etc) refused – giving up a £45 million annual contract – and leaving M&S looking foolish.Calculations.Mars sells Maltesers to sweetshops for 30p a pack. Their variable costs per pack are 10p and the fixed costs of running the Malteser division amount to £60,000 a day. Daily sales are 500,000 packs. a) Calculate current daily profit.b) Calculate the effect on profit of a 10% price rise, assuming that sales would fall by 5%.c) Calculate the % increase in profit.d) Recalculate the effect on profit if Cadbury’s responded to the 10% price rise by a huge advertising campaign on their products, causing the sales of Maltesers to fall by 15% instead of 5%.
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- Business, The Land, Corporation, Limited Liability Company, Limited company, sole trader