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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

2

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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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UEC Accounting Chapter 8 Accounting Ratios

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

8

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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

5

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UEC Accounting Chapter 8 Accounting Ratios

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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UEC Accounting Chapter 8 Accounting Ratios

Continue Question 1:

Re'uired+

- Calculate the following ratios+

a :ross Profit 7argin#

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UEC Accounting Chapter 8 Accounting Ratios

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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UEC Accounting Chapter 8 Accounting Ratios

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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UEC Accounting Chapter 8 Accounting Ratios

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

0

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UEC Accounting Chapter 8 Accounting Ratios

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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UEC Accounting Chapter 8 Accounting Ratios

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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UEC Accounting Chapter 8 Accounting Ratios

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