Question

The following financial ratios have been calculated for Nova Ltd for the year ended 30 June 2008:

                                      

	Actual results	Budgeted results	Previous year	Industry average
current ratio	1.97	1.92	1.87	1.92
Quick asset ratio	1.06	1.06	1.06	1.11
Inventory turnover	4.21	4.91	4.86	4.76
Net profit ratio	0.05	0.03	0.03	0.03
Gross margin	0.65	0.59	0.61	0.61

Required: Provide four (4) possible explanations for the results for the various ratios for Nova Ltd and outline their implications for the audit.

please provide different maximum of 250 words with unique writing from others.

Answer 1

Based on the Nova Ltd's financial statements data it is observed that almost all of the actual ratios are better than the budgeted ratios except the inventory ratio which is 4.21 (less than the Budgeted ratio of 4.91). We can also see that the financial performance of the current year is better than the previous year.

Possible explanations for the results of the various ratios for Nova Ltd and their implications for the audit are as follows :

1. Current ratio = current assets / current liabilities

Healthy (ideal) current ratio is 2:1

Nova Ltd's current ratio is 1.97 which is close to the ideal current ratio.

Nova Ltd's current ratio hass improved (1.97) as compared to previous year (1.87), also it is more than the industry standard (1.92) and budgeted figure (1.92), but it can be improved further by increasing of current assets or by decreasing of current liability.

Current ratio also says that Nova's ability to pay short term obligations has improved from previous year to current year when compared to industry average.

Hence, current ratio of Nova is in a healthy stage.

2. Quick ratio = quick assets / current liabilities

Calculation of quick assets = (current assets - inventory)

Healthy (ideal) quick assets = 1:1

Nova Ltd's quick ratio is 1.06 which is slightly better than the ideal ratio but a little less when compared to the Industry average (1.11). There is no change in quick ratio of Nova as compared to previous year. It is same to the budgeted and previous year figures.

Based on both current ratio and quick ratio, we as auditors can be assured that the company's ability to pay its short term obligations with its available current assets and liquid current assets (inventories are considered less liquid), is better than the previous year.

3. Inventory turnover ratio = Cost of goods sold / average inventory

Cost of goods sold = Opening Inventory + Net Purchases + Direct expense - Closing inventory

Average inventory = (Opening inventory + Closing inventory ) / 2

Inventory turnover ratio shows how many times a company has sold and replaced inventory during a given period (higher the better).

Inventory turnover ratio of the company (4.21) has decreased as compared to that of previous year(4.86), it means the company was not able to use its inventory efficiently to generate sales as compared to the previous year and that the cost of goods sold increased in the current year.

It is also lower than the industry standard and budgeted figure. Inventory turnover ratio is lower when compared to industry average in both the years i.e. previous and current, which means its ability to use the inventory to generate revenue is less when compared to industry average.

4. Net profit ratio = (net profit / sales) x 100

Net profit ratio of the company (0.05) has increased as compared to that of previous year (0.03). This means company made more profit as compared to the previous year, industry standard and budgeted figure. This also means that the overall expenses reduced in the current year

5. GP margin = (gross profit / sales) x 100

GP margin of the company (0.65) has increased as compared to that of previous year and industry standard (0.61). It is also more than the budgeted figure (0.59).

Overall the company is having better financial ratios as compared to that of previous year and industry standard. It is performing better as compared to the budgeted expectations.