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7/27/2019 Accounting Ratios - Principles of Accounting
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7/27/2019 Accounting Ratios - Principles of Accounting
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Current ratio = Current assets
Current liabilities
A ratio of 2:1 is considered to be a good standard, but it may vary depending upon the nature of the
business and other organizations in the same line of business.
2. Acid test (quick ratio)This ratio tests for insolvency if a business has sufficient liquid resources ( quick assets) to meet its
current liabilities. To calculate this ratio, closing stock should be removed from the current assets where
the stocks are not likely to be sold very quickly.
Acid test ratio = Current assets closing stock
Current liabilities
The standard for this ratio is 1:1, a lower ratio indicating insolvency
Use of assets (efficiency ratios)
1. Stock turn over (stock turn) ratio
This ratio shows how quickly the business sells its stock how many times the stock turns over in a
year.
The rate of stock turn over = Cost of sales
Average stock
Where, average stock = Opening stock + closing stock
2
If the rate increases, it may indicate efficiency is improving (sales are increasing) and if it reduces it may
mean that the efficiency is deterioting (the business has too much stock because the sales are slowing
down)
2. Debtors turn over ratio( Debtors collection period)
This ratio shows how long it is taking to collect debts from customers. The faster cash is collected from
debtors, the better the cash flow of the business. It also shows the credit control policy of the business.
Debtors collection period = Debtors x 365 days ( or 52 weeks or 12 months)
Credit sales
3. Creditors turn over ratio (creditors payments period)
This ratio shows how quickly the business pays its creditors. A longer period indicates that the business is
taking longer to pay its creditor and hence is holding on to cash which may lead the creditors to refuse to
sell to the business.
Creditors payments period = Creditors x 365 days ( or 52 weeks or 12 months)
Credit purchases
It is also important to compare the creditors payments period with the debtors collection period - ideally,
it should take longer to pay creditors than to collect monies from debtors.
Relationship between Mark up and Margin
Cost price + profit = Selling price.
Cost of sales + profit = Sales
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Advantages of accounting ratios
Limitations of accounting ratios
MCQ
A. Cost price/ profit B. Profit / selling price
C. Profit / cost price D. Cost price / loss
2. How is margin percentage calculated?
A. Profit / cost price x 100 B. Profit / selling price x 100
C. Profit / selling price D. Loss / selling price.
3. A trader charges 25% profit on cost price. What is this profit called?
A. Mark up B. Profit
C. Surplus D. Margin
4. A shop keeper is making 25% profit on sale price. What is this profit called?
A. Profit B. Surplus
C. Mark up D. margin
5. Which of the following equations is correct?
A. Cost price profit = selling price B. Cost price + profit = selling price
C. Cost price selling price = profit D. Selling price + cost price = profit
6. How is the rate of stock turn over calculated?
A. Cost of goods sold / opening stock B. Cost of goods sold / average stock
C. Cost of goods sold / closing stock D. Cost of goods sold / sales
7. The following relates to a sole traders business:
Average stock $ 12 600
Mark up 50% on cost
Stock turn over 7 times.
What is the amount of gross profit?
A. $ 44 100 B. $ 88 200 C. $ 25 200 D. $ 34 100
1. It helps to compare two or more business units.
2. We can compare the results of a business over two periods.
3. On the basis of ratios, the growth or the decline of the business can be understood very easily.
4. To plan for the future.
1. Only past events expressed in terms of money alone can be analysed.
2. Different accounting methods give different results that cannot not be compared.
3. No allowance is made for inflation, which makes comparison of results between different periods
meaningless.
4. Other non monetary and non financial factors are ignored (eg: staff relations, efficiency of the
management, business location, environmental conditions etc)
5. Only like with like items can be compared (similar sized businesses, different periods for the
same business, Plans and budgets.
1. How is mark up shown as a fraction?
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8. A firm sales are $ 150 000, the cost of sales is $ 90 000 and the expenses are $ 45 000.
What is the gross profit % to sales?
A. 10% B. 30% C. 40% D. 70%
9. A trader supplies the following details:
Cost of goods sold $ 5 600
Opening stock $ 500
Closing stock $ 900
What is the rate of stock turn over?
A. 7 times B. 6 times C. 8 times D. 9 times
10. K.King gives the following information at 31st Dec
Stock on 1st Jan $ 600
Purchases during the year $ 5 400
Average stock during the year $ 1 200
What is the amount of closing stock as at 31s Dec?
A. $ 3 600 B. $ 1 800 C. $ 600 D. $ 6 000
11. A trader bought goods for $15 000 and then sold 2/3 of them for $ 13 000. What would be his G.P?
A. $ 3 000 B. $ 15 000 C. $ 2 000 D. $ 13 000
Assignment questions
Q1. From the following information for two firms, Firm A and Firm B calculate
Q2. Here is a trading account.
Sales 50 000
Less Cost of goods sold
Opening stock 5 000
Add Purchases 42 500
47 500
Less Closing stock 10 000 37 500
Gross Profit 12 500
From the above, calculate :-
Q3. Here is a balance sheet.
Fixed assets
Premises 13 000
Machinery 5 000
Office equipment 2 500
20 500
Current assets
Stock 12 000
Debtors 4000
Bank 2000
18 000
Less Current liabilities
1. The gross profit percentage on sales for each firm.
2. The net profit percentage on sales for each firm.
Firm A ($) Firm B ($)
Sales 100 000 100 000
Gross profit 20 000 25 000
Net profit 5 000 5 000
1. Give one reason why the gross profits of the firms differ?
1. The gross profit percentage
2. The stock turn over for the year
3. If debtors are $ 6 250, the credit that is being taken on average
4. If creditors are $ 10 625, the credit that is being received on average
5. If net profit for this business is $ 7 500, the net profit percentage
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Creditors 6 000
Working capital 12 000
32 500
Financed by
Capital 30 000
+ Net profit 10 000
40 000
- Drawings 7 500 32 500
From the above, calculate ;-
Incoming search terms:
1. Current ratio
2. Acid test ratio
3. Return on capital employed
4. Comment on the figures you have calculated, comparing them with last years balance sheet which
showed a current ration of 1.5:1, a liquid ratio of 0.8:1 and a return on capital employed of 20%.
accounting ratio results
accounting ratios
Average collection period (debtor days) This ratio is used widely within businesses to measure the
calculating closing stock using current asset and liabilities and acid ratio test
what would a 2:1 ratio be for net income
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