Question

Prepare a short discussion of each calculated ratio, which you believe may be unsatisfactory, and explain why.

Answer 1

Ratios are classified on the basis of the parties of their usage. Accounting ratios are used to indicate the financial position of a firm. Ratios are classified:

On the basis of Balance Sheet

On the basis of Profit & Loss Account

On the basis of Mixed Statement

The above classification further grouped into:

1)Liquidity Ratio

2)Profitability ratio

3)Turnover Ratio

4)Solvency Ratio

Here im just considering Liquidity ratio to decribe a Breif summary :

--> LIQUIDITY RATIOS :

The scope to which there is quick convertibility of assets in to money, for the purpose of paying obligation of short-term nature can be termed as liquidity. Apropos to obtaining an indication of a firm’s ability to meet its current liabilities, the utility of the liquidity ratios is instrumental. As a flipside, however, it does not bring to the light, the effectiveness of the optimal management of cash resources. It is also termed as Short-Term Solvency Ratios. To measure the liquidity of a firm, the following Liquidity ratios are commonly used:

1) Current Ratio:

The relationship between current assets and current liabilities is established by Current Ratios. . It attempts to measure the ability of a firm to meet its current obligations. Current assets and current liabilities comprise of two pivotal components of this ratio. Assets that can be easily converted into cash, within the time frame of less than a year, can be termed as current assets. While, conversely, current liabilities encompass those liabilities which can be paid off with in a year.

Current Ratio = Current Assets / Current Liabilities

The ideal current ratio is 2: 1. It is a stark indication of the financial soundness of a business concern. When Current assets double the current liabilities, it is considered to be satisfactory. Higher value of current ratio indicates more liquid of the firm’s ability to pay its current obligation in time.

There are some Advantages of Current Ratio:

1)It measures the liquidity of the firm

2)It represents the working capital position of a firm

I believe current ratio may be unsatisfactory because of following :-

1)Its accuracy can be deterred as, pertaining to different businesses, depending on a variant of factors

2)Over-valuation of stock also contributes to its tipping accuracy

3)It measures the firm liquidity on the basis of quantity and not quality, which comes across as a crude method.

2) Ratio analysis:-

--> The term “ratio analysis” refers to the analysis of the financial statements in conjunction with

the interpretations of financial results of a particular period of operations, derived with the help of ‘ratio’. Ratio analysis is used to determine the financial soundness of a business concern.

a) Ratio analysis is a conceptual technique which dates back to the inception of accounting, as a

concept. Financial analysis as a scientific tool is used to carry out the calculations in the area of

accounting. In order to appraise the valid and existent worth of an enterprise, the financial tool comes

handy, regularly. Besides, it also allows the firms to observe the performance spanning across a

a long period of time along with the impediments and shortcomings. Financial analysis is an essential

the mechanism for a clear interpretation of financial statements. It aids the process of discovering, the

existence of any cross-sectional and time series linkages between various ratios.

Advantages of Ratio Analysis :

1)It facilitates the accounting information to be summarized and simplified in a concise and concrete form which is comprehensible to the user.

2)It depicts the inter-relationship between the facts and figures of various segments of business which are instrumental in taking important financial decisions.

3)Ratio analysis clears all the impediments and inefficiencies related to performance of the firm/individual.

4)It equips the management with the requisite information enables them to take prompt business -decisions.

b)I believe ratio analysis may be unsatisfactory because of following :-

1)Various environmental conditions such as regulation, market structures etc. vary for

different companies, operating in different industries. Significance of such factors is

extremely high. This variation may lead to a difference or an element of a discrepancy, while

comparing the two companies from diverse industries.

2)Financial accounting information is impacted and often subject to change, by estimates

and assumptions. Accounting standards allow scope for incorporating different accounting

policies, which impairs comparability and hence functionality of ratio analysis is less in such

situations.

3)Ratio analysis explicates association between past information while current and future

information is of more relevance and application to the users.