# YEAR 11 ACCOUNTING by dffhrtcv3

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```									YEAR 12 ACCOUNTING

Analysis and Interpretation
Liquidity
CLASSIFICATION OF
RATIOS/PERCENTAGES

Ratios/Percentages

Profitability            Liquidity       Financial Stability

We are looking at this
today!!!
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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