O Level Notes : Accounts - Interpretation of financial statements and accounting ratios
This topic is basically about learning the definitions and the formulas of the respective ratios. These ratios and the financial statements you learnt about in the previous chapters can be used to compare 2 or more businesses , let’s say, to decide which one to buy when you’re about to buy a business and are given couple of choices.
Gross margin: gross profit x 100%
Rate of stock turnover:
Cost of sales
Lesser the rate of stock turn over, slower the business would be.
Accounting ratios can only be used if the nature of businesses is the same and the time period of comparison is the same.
Current ratio : the comparison between assets which will become liquid within next 12 months with the liabilities which will be due to be paid within the next 12 months. This ratio is used to find out whether there are sufficient current assets to meet the liabilities.
Acid test ratio
Current assets – closing stock
No matter how successful a business apparently is, it may fail if it is not sufficiently liquid.
Debtor to sales ratio
The more money is tied up with debtors, the weaker the business would be.
Creditor purchase ratio
Shows how efficient our business is in terms of payment.