ACCOUNTING AND BUSINESS DECISIONS. Essay Example
Accounting and business decision
Ratios are defined as the quotient of two mathematical expressions, or the relationship between two variables. They may also be expressed differently .i.e. as a percentage, fraction and different relationships between numbers.
In most companies, ratio analysis has been found to be useful in financial statements analysis. The relationship between two figures can be expressed as a percentage or quotient. Ratios aid in analysis and interpretation, they help to determining whether the financial position of a firm is sound and that there are returns on the investments made by the business. (Stickney, &, Weil, &, Schipper, 2009) described ratios that are normally used in many of the organizations which include; profitability, asset efficiency, liquidity, gearing and investment ratios. In this context, we are going to discuss these ratios in depth.
Companies regard profit as the main indicator of an organizational success since they evaluate the success or failure of a business by estimating the profitability in relation to capital employed. This ratio indicates the level of success in achieving profits. The following are the formulas for profitability ratios.
Return on capital employed(R.O.C.E.) profit before interest and Tax X 100
450 X 100 = 41%
Asset turnover = ___ sales______ X 100
2000 X 100 =182%
This analysis shows that the method is strong when assessing the earnings of the shareholders and when assessing the efficiency of an organization.
This type of ratio indicates how well assets of an organization care used to create a cash flow return. For a company to reduce the level of wastage in generating cash flow, plant and equipment can be used instead of total assets. By doing so, this method provides useful information when comparing other organizations in the market. Important ratios under asset efficiency are:
Debtors ratio = debtors X 365
250 X 365 = 46 days
Creditors ratio = creditors X 365
145 X365= 26days
The strongest point of these ratios is that, an increase in this ratios shows that a company grows too quickly. Whereas a decrease in this ratios shows a downward trend in demand for the organizations products.
Most organizations analyses its ability to meet its current liabilities. The liquidity ratios show the liquidity position of the company. The main purpose is to gauge the ability of the business to meet its obligations (current liabilities).
Current ratio = current asset
20000 = 2:1
Quick/ acid test ratios = current assets- stock
20000-10000 = 1:1
Current ratio, 2:1 is more acceptable in a normal organization though it varies from farm to farm. For quick/acid test ratio, 1:1 is considered ideal since the number of assets are equal to the number of liabilities.
This ratio compares the contribution of financing by the owners to that of the firms creditors.
Debt- equity ratio = Total debt
Total owner’s Equity
500000 = 1
The ratio can also be expressed in this formula as:
Capital Gearing Ratio = fixed interest capital
In this case, owner’s equity seems grater hence the risk associated with the creditor’s contribution is minimized.
This type of ratio is used to minimize chances of risk for creditors and people investing in the company hence allowing entrepreneurs to improve their productivity and maximize profits.
Return on investments = profits after tax X 100
Total share capital plus reserves
That is the same as:
Return on owner’s equity = net profit after tax X 100
500 X 100 = 56%
This ratio indicates that the managers of the company are in position to get their profits back after imputing their finances in the business. It is clear enough that the owner’s contribution benefits them afterwards since they can be able to enjoy their profits.
According to (Stickney, &, Weil, &, Schipper, 2009), it is important to note that the financial position of a business can only be successful if only its activities remain stable and under a normal business operation. Hence, if the companies’ activities operate under the normal situation, it will not be able to enjoy the profits. In this case, the capital invested is seen to have generated enormous profits since it has been able to re-invest on the business while owners of the business sharing the remainder of the profits. The gearing ratios have enabled the managers to repay its creditors while expanding the firm by investing. So it has vividly seen that the companies position is in a better position since does not overtrade, while operating under normal business activities.
Stickney, P, &, Weil, L, &, Schipper, K, (2009), Financial Accounting An Introduction to Concepts, Methods and Uses, Cengage Learning, CA.
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