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

quickasset 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.

Answer 1

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.

Financial ratios are used by auditors to test the financial statements and get inferences from them and get a better picture of business operation

The auditors check the previous year ratios and also compare it to the industry average and asses the risks if the variance is too high or low

Current Ratio

**The current ratio is a liquidity ratio that measures whether a firm has enough resource to meet its short-term obligations. It compares a firm's current assets to its current liabilities.

**Current Ratio = Current Assets/ Current liabilities

**The standard current ratio is usually 2:1

**Nova Ltd's ratio is right now 1.97:1 which is quite close to the standard and not a cause for any bad things.

**It is also greater than the industry average and hence it is very good for the company.

It has also increased from the previous year, which is a very good indicator of the company's operations!

**The current ratio seems in line with the standards, hence the auditor doesn't have to perform any extra procedures and the risk of material misstatement is very low

Quick Assets Ratio

**The quick ratio is a liquidity ratio used to measure a company's liquidity. The quick ratio is also known as the acid test ratio. The quick ratio compares the quick assets, which means total amount of cash and cash equivalents plus marketable securities plus accounts receivable to the amount of current liabilities.

**Quick Assets Ratio = Quick Assets/ Current liabilities

**quick ratio is the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately

** standard Quick Ratio is 1:1

** Nova ltd. quick assets is 1.06 :1 which is near to the standard ratio hence Nova ltd quick ratio is sound.

**Compare to previous it is same.

**compare to industry average, it seems lees, but not problem, so there is not any problem happened to auditors

Inventory turnover

**Inventory turnover is the ratio which measure the number of times that the company convert its material to finished goods or ready for sales in a year or cycle period.

**it is measured using the formula

Inventory turnover ratio = Cost of goods sold / average inventory

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

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

**In other word inventory turnover ratio means Inventory turnover ratio indicates how many days a company is able to sell its inventory .

**Inventory turnover ratio of the company is decreased as compare compare to its previous period./ so it is case to increase the inventory in hand.

**Also compare to industry it is decreased.

Net profit ratio

**The net profit ratio is the ratio of after-tax profits to sales. It disclose the remaining profit after all costs of production, administration, and financing have been deducted from sales, and also deduct income taxes expenses.

** The purpose of this ratio is to evaluate the profitability of the business from its primary operations.

**Net profit ratio = Net profit / net sales revenue

**Its Net profit ratio are improved, compare to its previous period result

**And compare to industry standard, the net profit ratio were better.

Gross margin

**Gross margin is the difference between revenue and cost of goods sold divided by sales revenue. It is also profitability ratio used to measure the performance of the company.

**Gross margin = Gross profit / sales

Gross profit = sales - cost of goods sold

**compare to previous and industry standard, it is better, because it is increased.

**actual gross margin are higher than budgeted, so there is also improvement in efficiency of the company