Question 1

Choose the correct explanation for the liquidity (quick)ratio.
A)A measure of a business's ability to pay debts and obligations due beyond 1 year
B)A measure of a business's ability to pay debts and obligations due within 2 years
C)A measure of a business's ability to pay debts and obligations due within 1 year
D)A measure of a business's ability to pay debts and obligations due within 1 year,excluding the value of inventory and prepaid expenses

Accepted Answer

The liquidity (quick) ratio specifically measures a company's ability to cover its short-term obligations with its most liquid assets, hence it excludes inventory and prepaid expenses which are not as readily convertible to cash.

Question 2

The following financial statements are for Sioux Appliances,a sole trader,for the years ending 31 March 20X3,20X4 and 20X5.
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  Other information:
20X2 Accounts receivable were 52,000
20X2 Inventory were 19,000
20X2 Total assets were 360,000
20X2 Sales were 490,000
The bank overdraft limit is $20,000.
The mortgage is due for repayment in 20X7.
a Give a brief explanation of what each of the following ratios measure or mean: (You are not required to interpret the results from the financial statements at this point. )
i Net profit %,Return on equity %
ii Inventory turnover (days),Accounts receivable turnover (days)
iii Liquidity ratio (= Quick ratio),Debt ratio %.
b Calculate the following ratios for the 20X5 year.Show your calculations.
i Gross profit %,Net profit %,Return on equity %
ii Inventory turnover,in times per year and in days
iii Accounts receivable turnover,in times per year and in days
iv Current ratio,Liquidity ratio,Debt ratio %.
c Comment on the ratios calculated above,and the financial statement results for Sioux Appliances during the years 20X3-20X5 inclusive,in the following areas:
• profitability
• managerial performance
• financial stability.
d Recommend to Sioux what you consider to be the 6 most important things to do to correct her financial position and performance.

Accepted Answer

a i Net profit % measures the efficiency of net profit generation.
Return on equity % measures the rate of return on the owner's investment in the business.
ii Inventory turnover in days measures how many days on average it takes to sell stock.
Accounts receivable turnover measures how long on average it takes to collect money from customers.
iii Liquidity ratio measures the ability of a firm to pay its debts due within 1-2 months.
Debt ratio measures the % of the firm's total $ assets that are financed by borrowing.
b Ratios:
  c Profitability
• Gross profit % has been constant each year,but the net profit % has decreased considerably.This means that net-profit-making efficiency has decreased considerably.
• Return on equity has dropped below bank interest rates from 20X3-20X5,actual gross profit has almost halved,and actual net profit has almost disappeared.
• A decrease in advertising has led to a decrease in sales and profitability.
• Bad debts have risen slightly,suggesting bad credit control.
• Interest expense is very high and has increased each year.
Managerial performance
• Inventory turnover has slowed down considerably.It is taking about one and a half times longer to sell inventory in 20X5 compared with 20X3.
• Although sales dropped greatly from 20X3-20X5,the inventory balance only dropped slightly.This suggests inefficiency in inventory management.
• Accounts receivable turnover has improved dramatically each year from 20X3-20X5.Accounts receivable was very good at 37 days in 20X3;now it is even better at 21 days,which is well below the expected norm of 35-40 days.
Financial stability
• The current ratio was very close to the approximate ideal of 2 : 1 in 20X3.At 1.8 : 1 in 20X5 it is still reasonably close to 2 : 1.
• The liquidity ratio was very high in 20X3.It is still above 1 : 1 in 20X5,meaning the business is solvent (able to pay its short-term debts).
• The level of debt has risen to almost 79%.At this level,the business is quite risky,as banks are unlikely to lend more money to the firm.
• The total interest expense is also very high,which adds to the risk.
• Despite the decreasing sales,Accounts payable have risen,suggesting the firm has problems paying its debts.
• Drawings have been rising and were very high in the last year.
• The business cannot afford this level of drawings to continue.
d Recommendations
• Increase advertising back up to the 20X3 level to boost sales.
• Provide discount for cash to encourage cash sales (which are currently zero).
• Have a sale with low prices on old stock to reduce inventory level.
• Check and delete any slow-moving inventory items.
• Investigate if there are any errors in accounting records.
• If possible,sell or lease part of the land and buildings to enable more debt to be repaid.
• Reduce drawings back to the 20X3 level or lower to enable more debt to be repaid.
• Investigate ways to reduce the level of debt and therefore to reduce interest payments.

Question 3

If inventory turnover is slowing down,which of the following is not likely to be a factor?
A)The firm is stocking inventory that is becoming obsolete
B)The firm is has not implemented proper stock rotation methods
C)The firm is experiencing stock shortages for customers
D)The firm is experiencing a high level of stock returns from customers

Accepted Answer

Stock shortages for customers would not slow down inventory turnover, as the inventory would be quickly sold to meet customer demand. Options A, B, and D would all contribute to slower inventory turnover.

Question 4

Choose the correct definition for long-term viability.
A)The ability to produce cash from the business to meet current obligations
B)The ability to meet long-term obligations as they fall due for payment
C)The ability of the business to continue to operate profitably
D)The ability of the business to borrow further funds if needed

Accepted Answer

Long-term viability refers to the ability of a business to continue operating profitably over an extended period, ensuring its sustainability and success.

Question 5

Return on equity:
A)measures the dividends payable to owners on their investment
B)measures the net earnings payable to owners on their investment
C)can be compared with bank term deposit rates to provide a guide to success
D)can be compared with other investment opportunities to provide a guide to success

Accepted Answer

The answer of Return on equity:
A)measures the dividends payable to...

Question 6

The following financial statements are for Rupert's Appliances,a sole trader,for the years ending 31 March 20X3,20X4 and 20X5.
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a Calculate the following ratios for the 20X5 year only.Show your calculations.
i Gross profit %,Net profit %,Return on equity %
ii Inventory turnover (times per year),Inventory turnover (days)
iii Accounts receivable turnover (times per year),Accounts receivable turnover (days)
iv Current ratio,Liquidity ratio,Equity ratio %.
b Comment on the ratios calculated above,and the financial statement results for Rupert's Appliances during the years 20X3-20X5 inclusive,in the following areas:
• profitability
• managerial performance
• financial stability.
c Recommend to Rupert what you consider to be the 6 most important things to do to correct his financial position and performance.

Accepted Answer

The answer of The following financial statements are for Rupert's...

Question 7

If both gross profit margin and net profit margin are increasing:
A)net profit will be increasing
B)net profit will be decreasing
C)sales will be increasing
D)it is not possible to tell

Accepted Answer

The answer of If both gross profit margin and net...

Question 8

A price/earnings ratio above the industry average indicates that:
A)the market expects the firm to do well in the future in comparison with other firms
B)the market expects the firm to do badly in the future in comparison with other firms
C)the firm has been more profitable than other firms
D)the firm has been less profitable than other firms

Accepted Answer

A price/earnings ratio above the industry average indicates that the market expects the firm to do well in the future in comparison with other firms. This means that investors are willing to pay more for each dollar of earnings because they believe the company has strong growth prospects.

Question 9

Choose the correct definition for solvency.
A)The ability of the business to pay debts as they fall due for payment
B)The ability of the business to continue to operate profitably
C)The ability of the business to borrow further funds if needed
D)The ability of the business to attract new customers when needed

Accepted Answer

Solvency refers to the ability of a business to pay its debts as they fall due for payment. This is an important indicator of a company's financial health as it shows whether it has enough current assets to cover its current liabilities.

Question 10

If a firm drops its price to attract customers and gain a greater market share:
A)net profit margin will increase
B)net profit margin will decrease
C)gross profit margin will increase
D)gross profit margin will decrease

Accepted Answer

When a firm drops its price to attract customers and gain a greater market share, the gross profit margin will decrease. This is because the firm is sacrificing profit per unit in order to sell more units at a lower price. While this may increase overall revenue, it will decrease the profit margin on each individual sale.

Question 11

Choose the correct definition for liquidity.
A)The ability to produce cash from the business to meet current obligations
B)The ability to meet long-term obligations as they fall due for payment
C)The ability of the business to continue to operate profitably
D)The ability of the business to borrow further funds if needed

Accepted Answer

Liquidity refers to the ability of a business to produce cash from its operations to meet its current obligations, such as paying bills and salaries, without causing disruption to its business activities.

Question 12

The lower the debt ratio:
A)the harder it is for the business to borrow funds to carry it through a short-term cash shortage
B)the easier it is for the business to borrow funds to carry it through a short-term cash shortage
C)the more financially stable the business is
D)the higher its interest payments are likely to be

Accepted Answer

The answer of The lower the debt ratio:
A)the harder it...

Question 13

Choose the correct statement: the debt ratio:
A)shows the percentage of assets which are funded by debt finance
B)shows the percentage of assets which are funded by equity finance
C)shows the percentage of liabilities which are funded by debt finance
D)shows the percentage of liabilities which are funded by equity finance

Accepted Answer

The debt ratio shows the percentage of assets which are funded by debt finance. It is calculated by dividing total debt by total assets. Therefore, option A is the correct statement.

Question 14

If accounts receivable (debtors)turnover is speeding up,which of the following is not likely to be a factor?
A)The firm has implemented very stringent credit granting procedures for new customers
B)The firm issues all its invoices promptly and accurately to clients
C)The firm contacts slow-paying clients quickly and effectively concerning payment of overdue accounts
D)The firm has instituted 'no-interest-for-6-months' terms for customers

Accepted Answer

Offering 'no-interest-for-6-months' terms for customers may actually slow down accounts receivable turnover as it encourages customers to delay payment. A, B, and C are all factors that would likely speed up accounts receivable turnover by ensuring timely collection of payments from customers.

Question 15

The solvency test:
A)is a requirement for companies to meet before and after distributing dividends
B)is a requirement for directors to verify that the company meets before and after distributing dividends
C)requires the company to be able to meet its short-term debts as they fall due
D)requires the company's assets to be greater than its liabilities
E)all of the above

Accepted Answer

The solvency test is a financial assessment that companies must pass to ensure they can meet their long-term financial obligations, including before and after distributing dividends. It involves verifying that the company can pay its debts as they come due and that its assets exceed its liabilities, a process typically overseen by the company's directors.

Question 16

Choose the correct explanation for the current ratio.
A)A measure of a business's ability to pay debts and obligations due beyond 1 year
B)A measure of a business's ability to pay debts and obligations due within 2 years
C)A measure of a business's ability to pay debts and obligations due within 1 year
D)A measure of a business's ability to pay debts and obligations due within 1 year,excluding the value of inventory and prepaid expenses

Accepted Answer

The current ratio measures a business's ability to pay debts and obligations due within 1 year.

Question 17

Choose the correct definition for financial stability.
A)The ability to produce cash from the business to meet current obligations
B)The ability to meet long-term obligations as they fall due for payment
C)The ability of the business to continue to operate profitably
D)The ability of the business to borrow further funds if needed

Accepted Answer

Financial stability refers to a business's ability to meet its long-term obligations as they fall due for payment. This includes having a sustainable level of debt, a healthy cash flow, and sufficient assets to cover liabilities in case of unexpected events. It allows the business to operate without the risk of bankruptcy or insolvency. The other options (A, C, and D) are important factors in financial management, but they do not fully encompass the concept of financial stability.

Quiz 10: Analysis and Interpretation of Financial Statements

Choose the correct explanation for the liquidity (quick) ratio.

If inventory turnover is slowing down,which of the following is not likely to be a factor?

Choose the correct definition for long-term viability.

Return on equity:

If both gross profit margin and net profit margin are increasing:

A price/earnings ratio above the industry average indicates that:

Choose the correct definition for solvency.

If a firm drops its price to attract customers and gain a greater market share:

Choose the correct definition for liquidity.

The lower the debt ratio:

Choose the correct statement: the debt ratio:

If accounts receivable (debtors) turnover is speeding up,which of the following is not likely to be a factor?

The solvency test:

Choose the correct explanation for the current ratio.

Choose the correct definition for financial stability.