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Answers

1 (e) In order to comment more accurately on the results of report analysis and ratio calculations, one should and would want the other information available as listed in (a) to (d).

2 (f) The liquidity ratio is:

current assets, excluding inventory and prepayments x 100

current liabilities – overdraft 1

3 (c) The ratio formula is that of the quick asset ratio. This ratio is also known as the acid test and the liquid ratio.

4 (a) Liquidity/Solvency is the indicator for a business’s ability to meet its obligations as and when they fall due.

5 (d) Financing is the indicator that compares the business’s funding from the owner’s contribution compared with outside funding agents.

6 (b) Activity reflects the entities means and basic objectives. These will depend upon both internal and external factors.

7 (c) Profitability is the measure of the business’ ability to generate enough revenue to more than off-set the costs in generating the revenue.

8 (e) All the factors (a) to (d) place limitations on ratio analysis.

9 (a) Efficiency Ratios are designed to measure the effectiveness of the management policies of the business, such as efficiency in collecting accounts receivable.

10 (b) One of the most significant measures of profitability is the rate of return on owner’s investment.

True / False

1 True

Cost of Sales: COS = 96% x Credit Sales = $432,000

2 True

Accounts Receivable

(Ave Accounts Receivable/Credit Sales)* 360 = Collection Period

(Accounts Receivable/450,000)* 360 = 20 days

Accounts Receivable = $ 25,000

3 False

Opening and Closing Inventory Valuations

COS/Ave Inventory = Inventory Turnover (times)

432,000/Ave Inventory = 16 times

Ave Stock = $ 27,000 = (OS + CS)/2

Ave Stock = (lx + 1.5x)/2 = 2.5x/2

Therefore X = 27,000 x 2/2.5

= $ 21,600

Opening Stock = $ 21,600

Closing Stock = 1.5x

Opening Stock = $ 32,400

4 False

Profit Margin Ratio is equal to the difference between the Gross Profit Ratio and the Operating Expense Ratio.

5 False

For a selling business, the Operating Expense Ratio is equal to the sum of: General and Administration Ratio, Selling and Distribution Ratio and the Financial Ratio. The Cost of Sales Ratio would not be included.

6 False

The Liquidity Ratio is the best indicator of the business’ ability to cope with its financial commitments for the next 12 months, not its profitability.

7 False

The Accounts Receivable Ratio is expressed in days for its collection period ie: (Average Accounts Receivable/Net Credit Sales) x 365 days.

8 True

The accounting policies from are business to the next are likely to differ. The final reports could differ and areas of cash and accrual accounting could also differ.

9 False

The budgeted and actual results for a number of years will be little help to comment on the business’s trends. The data really needed for trend ratio analysis for a number of years is the Income Statements and Balance Sheets of the business.

10 False

The alternative name for the Working Capital Ratio is the Current Ratio.

Match the Word to the Statement

1 B - Debtors Collection Period and unit of expression

Average debtors for the period divided by the amount of credit sales all multiplied by 365 days. The unit for this ratio is days.

2 C - Rate of Return on Owner’s Investment and unit of expression

Profit divided by the average equity for the period. The ratio unit is expressed as a percentage.

3 D - Rate of Return on Assets and unit of expression

The profit earned spread over the average assets for the period expressed as a percentage.

4 E - Debt to Equity Ratio and unit of expression

Total Liabilities of the entity compared with the Equity share expressed as a percentage.

5 F - Acid Test and unit of expression

Current Assets - Inventory - Prepayments + Marketable Securities, divided by Current Liabilities – Overdraft, expressed as a percentage.

6 A - Inventory Turnover

Cost of sales divided by the average inventory on hand. The unit for this ratio is number of times.

7 H - Alternative name for Acid Test Ratio and unit of expression

Quick Ratio or Liquidity Ratio. The unit for this ratio is expressed as a percentage.

8 G - Gross Profit Ratio and unit of expression

(Net Sales – COS) / Net Sales x 100 / 1. The unit for this ratio is expressed as a percentage.

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