financial statement analysis

Question 1

explain the term liquidity

Answer 1

liquidity is the ability of the business to repay its current liabilities when they fall due

Question 2

working capital formula (liquidity)

Answer 2

total CA - total CL

Question 3

current ratio (liquidity)

Answer 3

total CA/total CL

Question 4

current ratio (liquidity)

Answer 4

total CA/total CL

Question 5

quick ratio (liquidity)

Answer 5

total CA- inv- prepayments/total CL

Question 6

suggest two measures __ may take to improve its cash flow position

Answer 6

1- sell excess non-current assets for cash
2- obtain additional bank loan

Question 7

importance of liquidity

Answer 7

when a business does not have sufficient cash to pay for goods or services, suppliers are not willing to sell goods or services to the business and the business has no goods or services to offer to customers.

Question 8

explain one problem faced by the business if they have insufficient working capital

Answer 8

1- insufficient cash to pay for daily operating expenses, for example, rent, utilities and wages
2- unable to take advantage of cash discounts because business is unable to pay promptly.

Question 9

analysis for working capital

Answer 9

this means that the business has $___ of excess current assets after paying off the short-term debts of the business (hence, the business can use this amount for its day to day operating expenses)

Question 10

analysis for current ratio

Answer 10

this means that the business has $__ of current assets to support every $1 of current liabilities that it owes

Question 11

analysis of quick ratio

Answer 11

this means the business has $___ of quick assets to support every dollar of its immediate debt

Question 12

liquidity worsening because?

Answer 12

1- worsening inventory position from one year to another (inventory value increase)
2- cash at bank/cash in hand value decreases
3- Trade payables ($24 300) is worse than ($11 200), and so the higher trade payables will add on to its financial burden in the short-term.

Question 13

define profitability

Answer 13

measures the ability of the business to generate excess income to cover its expenses

Question 14

suggest ways to improve the profitability of the business

Answer 14

1- sell goods at a higher selling price
2- the business could cut down on unnecessary expenses to improve profitability eg move to a smaller shop with the similar human traffic with cheaper rent
3- find ways to increase its other income to increase its profitability eg it can sublet part of the shop space to earn rental income

Question 15

explain the importance of profitability

Answer 15

1- measures ability to continue operating and sustain the business in the long term
2- measures ability to reward employees and retain them to continue working for the business

Question 16

explain the difference between profitability and liquidity

Answer 16

profitability refers to the business’ ability to generate excess income to cover up its expenses while liquidity refers to the ability of the business to repay its current liabilities when they fall due

Question 17

explain how a profitable business may not be liquid

Answer 17

1- it may have difficulty in collecting payment from its credit customers
2- it may have excessively prepaid for their expenses

Question 18

formula for mark up on cost

Answer 18

gross profit/cost of sales x 100

Question 19

formula for gross profit margin

Answer 19

gross profit/net sales revenue x100 (%)

Question 20

formula for profit margin

Answer 20

profit for the period/net sales revenue x 100 (%)

Question 21

formula for return on equity

Answer 21

profit for the period/avg equity x100 (%)

Question 22

analysis for mark up on cost

Answer 22

this means that the business earns ___ cents of gross profit for every dollar of cost of sale that it incurs

Question 23

gross profit margin analysis

Answer 23

this means that the business earns ___ cents of gross profit for every dollar of net sales revenue earned

Question 24

profit margin

Answer 24

this means that the business earns ___ cents of profit for every dollar of net sales revenue earned

Question 25

return on equity analysis

Answer 25

this means that the business earns ___ cents of profit for every dollar of capital contributed by the owner

Question 26

reasons for worsening and improving profitability

Answer 26

1- not managing its expenses as well as___ 2- able to set a higher selling price on its products or able to purchase its goods at lower cost price

Question 27

what is inventory management

Answer 27

inventory management is about deciding the amount of inventory that the business should have. it should not buy too much or too little inventory. business needs to maintain inventory at an optimal level to meet customer demand

Question 28

consequences of having a low rate of inventory turnover

Answer 28

1- inventory could become obsolete and business my incur losses 2- cash would be tied up in inventory instead of being used in more profitable areas 3- business may incur additional storage cost to store the inventory

Question 29

ways in which rate of inventory turnover can be improved

Answer 29

1- provide trade discounts to customers to encourage them to buy in bulk and regularly 2- attract more customers through marketing campaigns

Question 30

ways in which days sales in inventory can be improves

Answer 30

1- offer trade discounts to cut down selling price so as to encourage customers to buy the goods so as to clear stock and improve inventory turnover rate 2- do sales promotions

Question 31

rate of inventory turnover formula

Answer 31

cost of sales/ avg inventory (times)

Question 32

rate of inventory turnover analysis

Answer 32

this means that the business was able to sell and replenish its inventory ___ times in the accounting year

Question 33

days sales in inventory formula

Answer 33

avg inv/ cost of sales x 365 days (days)

Question 34

days sales in inventory analysis

Answer 34

this means the business took ___ days to sell its inventory in that accounting year

Question 35

ways to improve efficiency in trade receivables management

Answer 35

1- monitor collection patterns closely 2- offer cash discounts to encourage early payment by credit customers 3- grant credit only to customers who are financially stable

Question 36

rate of trade receivables turnover formula

Answer 36

net credit sales revenue/ average net trade receivables (times)

Question 37

rate of TR turnover analysis

Answer 37

this means that the business collects approximately ___ times of payments from TR in an accounting year

Question 38

trade receivables collection period formula

Answer 38

avg net TR/ net credit sales rev x 365 days (days)

Question 39

trade receivables collection period analysis

Answer 39

this means that the business spends approximately ___ days in an accounting year to collect payment from its credit customers

Question 40

reason for worsening of rate of inventory turnover

Answer 40

increased inventory holdings which can be seen from the worsening inventory balance from $50000 at 2021 to $60000 in 2022