accounting ratios - student
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UEC Accounting Chapter 8 Accounting Ratios
Chapter 8 Accounting Ratios for Accounts interpretation
Definition:
A set of figures to use for accounts interpretation, such as Profit and Loss Account, Balance Sheet, CashFlow Statement !o interpret means e"plain something in simple terms for the #enefit of another person
!his approach calls $Ratio anal%sis&
Ratio Anal%sis is a techni'ue used to e(aluate the performance of a compan% )t assumesthat there is a
relationship #etween one accounting figure and another in the financial statements
!he interpretation of accounts in(ol(es the anal%sis of financial statements in order to disco(er the
strengths and wea*nesses of a compan% )t aids the ma*ing of sound #usiness decisions
!he users of financial statements also *nown as Sta*eholders and it comprise+
- E"isting and Potential Shareholders
.- E"isting and Potential Loan Creditors/- E"isting, potential and past emplo%ees
0- Anal%sts and ad(isors 1 stoc*#ro*ers, trade unions
2- Business contacts 1 customers, suppliers, competitors3- !he go(ernment 1 ta" authorities, trade agencies
4- !he pu#lic 1 ta"pa%ers, consumers, pressure groups
8- !he management of the compan%5- Potential )n(estor
!he interpretation is used to assist in+
- )n(estment 6ecisions.- Credit Facilities
/- 7anagement Control
)n order to pro(ide the a#o(e parties with a method of measuring the strengths and wea*nesses of a
compan%s financial position, the use of accounting ratios has #een de(eloped
A ratio is the arithmetic relationship #etween two figures in a set of financial statements )t is onl% of
(alue if used as a #asis of comparison either+
a- )nternall%
9ith the compan%s results of pre(ious periods, or other sections of the compan%, or withestimated ratios
#- E"ternall%
9ith the results of other companies in similar industries
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UEC Accounting Chapter 8 Accounting Ratios
8 Ratios :roup
!here are 0 ma;or groups of ratios normall% used+
- Profita#ilit% 1 the efficienc% in profit generation
.- Li'uidit% 1 the financial sta#ilit% of the compan%
/- :earing 1 how is the compan% financed
0- )n(estment 1 the return to in(estors
Formula !a#le + Profita#ilit% Ratios
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UEC Accounting Chapter 8 Accounting Ratios
In Limited Company: Definition of Capital Employed
- >rdinar% Shareholders Capital Emplo%ed
a Paid up share capital# >rdinar% Share Capital Reser(e
c !otal Assets 1 Preference Share Capital 1 !otal Lia#ilities
Rate of Return Profit after ta" 1 Preference Share 6i(idends
on >rdinar% Shareholders ????????????????????????????????????????????????????????? " @@
Capital Emplo%ed >rdinar% Shareholders E'uit%
= Rate of Return on >wners E'uit%, Rate of Return on >rdinar% Shareholders E'uit%-
.- All Shareholders Capital Emplo%eda >rdinar% Share Capital Reser(es Preference Share Capital
# rdinar% Share Capital Reser(es Preference Share Capital Long?term Lia#ilities
# !otal Assets 1 Current Lia#ilities
c Fi"ed Assets Current Assets 1 Current Lia#ilitiesd Fi"ed Assets 9or*ing Capital
Rate of Return Profit #efore ta" )nterest on Long?term Lia#ilities
on Long?term ????????????????????????????????????????????????????????????????? " @@
Capital Emplo%ed Long?term Capital Emplo%ed
0- !otal Capital Emplo%eda >rdinar% Share Capital Reser(es Preference Share Capital Long?term Lia#ilities
Current Lia#ilities# !otal Assets
Rate of Return Profit #efore ta" )nterest on Long?term Lia#ilities
on !otal )nterest on Current Lia#ilitiesCapital ?????????????????????????????????????????????????????????????????????? " @@
Emplo%ed !otal Capital Emplo%ed
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UEC Accounting Chapter 8 Accounting Ratios
Formula !a#le .+ Li'uidit% Ratios = Short?term Sol(enc% Ratios -
A #usiness fails when it cannot pa% its de#ts !he ratio of assets to lia#ilities indicates how easil%
de#ts can #e paid
pening Stoc* Closing Stoc* .
A(erage 6e#tors >pening 6e#tors Closing 6e#tors .
0
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UEC Accounting Chapter 8 Accounting Ratios
Continue Li'uidit% Ratio+
rdinar% Share Capital Reser(es
Long?term Lia#ilities Preference Share Capital
???????????????????????????????????????? "@@ >rdinar% Share Capital Reser(es 6e#ts
Profit #efore !a" )nterest ?????????????????????????????????? " @@
)nterest
Also *nown as+
6e#ts
????????????????????? " @@ >wners E'uit%
!o compare internal fund
portion against e"ternalfund portion
!o compare the e"ternalfund portion to total fund
Ratio small less ris* or
(ice?(erse
!o calculate the power of
interest pa%ment
Bigger Ratio stronger
power to pa% interestLess ris* to creditors
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UEC Accounting Chapter 8 Accounting Ratios
Formula !a#le 0+ )n(estment Ratios
!o measure the return for in(estors !he ratios can #e #ased on di(idend or on earnings
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UEC Accounting Chapter 8 Accounting Ratios
E"amples on Profita#ilit% Ratios+
:ross Profit and
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E"ample on Returns on Capital Ratios+
Kin !ong Ltd
E"tracted Balance Sheet as at / 6ecem#er .@@2
R7!otal Assets 42,@@@
Current Lia#ilities =42,@@@- including Ban* o(erdraftLong?term Lia#ilities+.J 6e#entures =.,@@@-
88,@@@
>rdinar% Shares R7@2@ /@,@@@@J Preference Shares R7 .@,@@@
Reser(es /8,@@@
88,@@@
R7Profit #efore ta" interest .5,.@@
Estimated Corporation ta" 2,@@@
)nterest on Ban* >(erdraft ,.@@6e#enture )nterest ,00@
Appl% the a#o(e data to calculate the following ratios+
- Rate of Returns on owners E'uit%
.- Rate of Return on all shareholders Capital Emplo%ed
/- Rate of Return on Long?term Capital Emplo%ed
0- Rate of Return on !otal Capital Emplo%ed
Solution+
Rate of Return Profit after ta" 1 Preference Share 6i(idends
on >rdinar% Shareholders ????????????????????????????????????????????????????????? " @@Capital Emplo%ed >rdinar% Shareholders E'uit%
??????????????????????????????????????????????????????? "
J
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UEC Accounting Chapter 8 Accounting Ratios
Rate of Return Profit after ta"
on All Shareholders ??????????????????????????????????????? " @@
Capital Emplo%ed Shareholders Fund
???????????????????????????????????????????? "
J
Rate of Return Profit #efore ta" 1 )nterest on Long?term Lia#ilities
on Long?term ?????????????????????????????????????????????????????????????????? " @@Capital Emplo%ed Long?term Capital Emplo%ed
??????????????????????????????????????????????????????? "
J
Rate of Return Profit #efore ta" 1 )nterest on Long ? )nterest on Currenton !otal term lia#ilities lia#ilities
Capital Emplo%ed ???????????????????????????????????????????????????????????????????????? " @@
!otal Capital Emplo%ed
?????????????????????????????????????????????????????????????????? "
J
9or*ings =-+ Profit #efore ta" and interest .5,.@@Less+ Ban* >(erdraft )nterest =,.@@-
6e#enture )nterest =,00@-
Profit #efore !a" 26,560
Less+ !a"ation =2,@@@-Profit after !a" 21,560
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Practice Questions:
Question 1
!he following are the financial statements for two similar t%pes of Stationer% Compan%
!rading and Profit and Loss AccountFor !he %ear ended /@ Iune .@@3
ABC Compan% 6EF Compan%
R7 R7 R7 R7
Sales 5@,@@@ @,@@@Less+ Cost of :oods Sold
>pening Stoc* .@,@@@ 4,2@@
Purchases 3@,@@@ 88,2@@ 8@,@@@ @3,@@@
Less+ Closing Stoc* =2,@@@- =32,@@@- =.@,@@@- =83,@@@-
:ross Profit .2,@@@ .0,@@@6epreciation .@@@ .,2@@
>ther E"penses 8,@@@ =@,@@@- 3,2@@ = 5,2@@-
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Continue Question 1:
Re'uired+
- Calculate the following ratios+
a :ross Profit 7argin#
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Question 2
!he following are the summariNed !rading and Profit and Loss Accounts and Balance Sheets of :O) Bhd
for the %ear ended / 6ecem#er .@@0 and .@@2+
!rading and Profit and Loss AccountFor !he %ear ended / 6ecem#er
.@@0 .@@2
R7 R7 R7 R7Sales ? Cash @,@@@ 2,@@@
? Credit 02@,@@@ 03@,@@@ 23@,@@@ 242,@@@
Less+ Cost of :oods Sold>pening Stoc* /@,@@@ 2@,@@@
Purchases /.@,@@@ 02@,@@@
/2@,@@@ 2@@,@@@Less+ Closing Stoc* =2@,@@@- =/@@,@@@- =@@,@@@- =0@@,@@@-
:ross Profit 3@,@@@ 42,@@@
Selling and 6istri#ution = 3@,@@@ - = 8@,@@@ -
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Continue Question 2:
Re'uired+
- Calculate the following ratios+
a :ross Profit 7argin# rdinar% Shareholders Capital Emplo%ed
d Stoc* !urno(er Period =7onths-
e Current Ratiof Duic* Ratio
g 6e#tors !urno(er Period =7onths-
h Creditors !urno(er Period =7onths-
.- Compare the ratios and percentages computed and discuss :O) Bhds performance for #oth %ears
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Question 3
IL Bhds issued and full% paid?up capital is as follows+
R7
2@,@@@ 8J Preference Shares of R7 each 2@,@@@2@,@@@ >rdinar% Shares of R7 each 2@,@@@
.@@,@@@
!he following information is rele(ant as to its financial %ear ;ust ended+
Profit after ta"ation at 0@J + R73@,@@@
. >rdinar% di(idend paid + .@J
/ 7ar*et price of ordinar% share + R72
Re'uired+
a 6i(idend Kield
# >rdinar% 6i(idend Co(er
c Earnings per Share
d Price Q Earnings Ratio
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Question 5 14%
:i(en the !rading and Profit and Loss Accounts and Balance Sheets of CO !rading and COK Sdn Bhd
for the period ended / 6ecem#er .@@2+
!rading And Profit And Loss Accounts for the %ear ended / 6ecem#er .@@2CO !rading COK Sdn Bhd
Sales?Cash
?Credit
>pening stoc*Purchases
Less+ Closing stoc*:ross profit
Less+ Administration Financial E"penses Selling 6istri#ution E"penses
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Question 6 20%
9rite out the formulas of the accounting ratios used in compan% reports+
=- Rate of Return on Capital Emplo%ed #% Suppliers of Long?term Capital
=.- Rate of Return on Capital Emplo%ed #% >rdinar% Shareholders
=/- Stoc* !urno(er Ratio
=0- A(erage
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Question 7 20%
!he following were the Balance Sheets as at / 6ecem#er .@@2 of two companies which distri#uted the
same t%pe of goods+
Sdn Bhd KK Sdn Bhd
Fi"ed Assets =rdinar% Shares Capital
Retained EarningCreditors
R7
2.@,@@@5.,@@@
38,@@@
.@,@@@8@@,@@@
/.@,@@@
0@@,@@@8@,@@@
8@@,@@@
R7
/.@,@@@08,@@@
4,@@@
45,@@@
030,@@@
/.@,@@@
30,@@@8@,@@@
030,@@@
!he !rading And Profit And Loss Accounts for the %ear ended / 6ecem#er .@@2 were shown #elow+
R7 R7
Sales
>pening stoc*
Purchases
Less+Closing stoc*
Cost of goods sold:ross profitLess+E"penses