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YEAR 11 ACCOUNTING

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YEAR 11 ACCOUNTING Powered By Docstoc
					YEAR 12 ACCOUNTING


Analysis and Interpretation
Liquidity
CLASSIFICATION OF
RATIOS/PERCENTAGES

                    Ratios/Percentages

Profitability            Liquidity       Financial Stability



                We are looking at this
                today!!!
  How to evaluate businesses’ results?
  Please follow the steps as follows:
 Calculate Percentages/Ratios
 Explain the meaning of the Percentage/Ratios
                         Unsatisfactory
  Identify the trend
                         Trend          Look at the financial
                                      statements and formula and
Satisfactory Trend                    identify what has been
                                      changed?
 Look at the financial
 statements and formula and
 identify what has been            Why was there a change in
 changed?                          the financial statements?


                                   Provide a recommendation/s to
 Why was there a change in
                                   overcome the unsatisfactory
 the financial statements?
                                   trend.
Liquidity

Liquidity means the ability of a business
to repay short-term debts and to meet
unexpected needs of cash.

Short-term means within 12 months.
Measures of Liquidity

The following ratios are under the area of
Liquidity:

    Current Ratio
    Liquid Ratio
Current Ratio
                                    BENCHMARK

                                           2:1

Meaning:    It means for every $1 of current liabilities,
                  there are $X current assets available
to pay            the current liabilities in the next 12
                  months. It tells users that the
business is             able/unable to settle its debts
in the next             accounting period.
Example

If the current ratio in 2005 was 2.5:1. Try to write the
meaning of the ratio.

This means for every $1 of current liabilities, there
were $2.5 of current assets available to pay current
liabilities within the next 12 months. This tells
users that the business is ABLE to pay its debts
which are due within the next 12 months.
Calculation
                       2005              2006
Current Assets
Cash on Hand          500               500
Bank                3,000              N/A
A/Receivable       12,000            10,000
Inventory          20,000            18,000
Prepayment            800 36,300        600   29,100
Current
Liabilities
Accounts Payable   15,000            14,000
Bank (secured        N/A    15,000   4,500    18,500
$1,000)
Calculation

              2005   2006




Current
 Ratio
Satisfactory/Unsatisfactory Ratio

The current ratio in 2006 showed a
SATISFACTORY or UNSATISFACTORY result.



The next step is to describe the reason with
          using the Balance Sheet.
Identify the trend

The Current Ratio showed a
SATISFACTORY or UNSATISFACTORY trend.
Reason

Remember, we need to include the following
when providing reason/s:

    Information from the financial
     statements
    Reasons behind the information (you need
     to give an example)
Reason for trend (surface level)

The reason for the unsatisfactory ratio is there has
been a significant decrease in the bank balance (ie from
a positive balance to an overdraft).
Reason for trend (deep level)

An increase in the bank overdraft can be caused by the
following:

     Excessive Cash Drawings by the owner;
     Purchase of a piece of property, plant and
      equipment for cash;
     Repayment of a Non Current Liabilities


     This answer is not good enough because
         we have not yet answered WHY
Recommendations
To overcome this unsatisfactory ratio, either
INCREASE current assets or DECREASE current
liabilities, such as:

    Purchase PPE by borrowing a long term loan (to
     reduce the big outflow of cash suddenly)
    Dispose of any old PPE to obtain cash
    Owner’s can make an extra cash contribution
    Reduce the level of cash drawings
    Borrow a long term loan to ease the shortage of
     cash
Is an over-high current ratio (like 5:1) a
good thing?
No, because this tells users that the business cannot
use its excess cash efficiently to generate further
income.

Excess cash means the amount of cash left over after
settling all liabilities due within the next 12 months.

Businesses should invest their excess cash into
investments, such as shares, term deposits etc to earn
interest.
                                        BENCHMARK
Liquid Ratio                                1:1
                            Liquid Assets




                        Liquid Liabilities


Liquid Ratio measures a business’s ability to repay its
debts which are due immediately (i.e. within 2 – 3
months).
Meaning
This means for every $1 of liquid liabilities, there is
$X.XX of liquid assets available to pay liquid liabilities
within the next 2 – 3 months, which tells users that the
business is able/unable to repay debts which are due in
the next 2 – 3 months.

For example: Liquid Ratio in 2005 was 1.5:1. It means
for every $1 of liquid liabilities, there is $1.50 of liquid
assets available to pay liquid liabilities within the next
2 – 3 months, which means the business is ABLE to
repay debts which are due in the next 2 – 3 months.
Calculation
                       2005              2006
Current Assets
Cash on Hand          500               500
Bank                3,000              N/A
A/Receivable       12,000            10,000
Inventory          20,000            18,000
Prepayment            800 36,300        600   29,100
Current
Liabilities
Accounts Payable   15,000            14,000
Bank (secured        N/A    15,000   4,500    18,500
$1,000)
Calculation

              2005   2006




 Liquid
 Ratio
Satisfactory/Unsatisfactory Ratio

The liquid ratio in 2006 showed a
SATISFACTORY or UNSATISFACTORY result.



The next step is to describe the reason with
          using the Balance Sheet.
Identify the trend

The Liquid Ratio showed a
SATISFACTORY or UNSATISFACTORY trend.
Reason for trend (surface level)

The reason of an unsatisfactory ratio is :

     A high level of inventory on hand despite the level
      of inventory of hand showing a decreasing
      trend (inventory could not turn into cash in the
      next 2 – 3 months) and

     A significant increase in the bank overdraft.
      (from a positive balance to overdraft).
Reason for trend (deep level)
Possible reasons for having too much inventory on hand:
        Poor purchase policy, such as buying inventory
         without double checking the level of stock on
         hand.
        Charge products at excessive high price, which
         means people are less able to afford to buy the
         products.

    An increase in bank overdraft can be caused by the
    following:
          Excessive Cash Drawings by the owner;
          Purchase of a property, plant and equipment by
           cash;
Recommendations
To overcome an unsatisfactory ratio, can be achieved by the
following:

      Purchase of PPE by borrowing a long term loan (to reduce the big
       outflow of cash suddenly)
      Dispose of any old PPE to obtain cash
      Owner to contribute extra cash
      Reduce the level of cash drawings
      Borrow a long term loan for easing the shortage of cash
      Sell inventory at a lower price to get rid of inventory
      Review the purchase policy to ensure no excess inventory is
       bought
      Try to ask for a larger amount of secured bank overdraft

				
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posted:4/4/2013
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