Question

Options #1 and #2: Business Organizations, Classified Balance Sheets, and Ratio Analysis This week, you are required to complete one of two Critical Thinking assignments. These are assignments for which there is no time limit; however, the assignment must be completed in one sitting. You cannot leave the assignment and come back to it, so please allow yourself enough time to answer all the questions. Note that you have only one attempt to complete the assignment, so ensure that you are prepared. The assignment for this week opens at the start of Week 1. The option you choose is due by 11:59 PM MT on Sunday of Week 1. Please refer to CSU Global late policy for Critical Thinking assignments if you have any questions on due dates. Required: Complete the following activities: Part A: Complete Option 1 or 2 of this week's Critical Thinking assignment in WileyPLUS. Part B: Written Component Write an explanation on a specific ratio of your choice used to analyze financial statements. Explain how to calculate the ratio, what it measures, and what it tells an analyst about the company. Finally, select a company's recent financial statements, calculate the ratio for your selected company, and explain what this ratio tells you about the company's financial health or performance. Your paper should be at least one page in length and conform to CSU Global Guide to Writing and APA (Links to an external site.). Include at least two scholarly references in addition to the course textbook. Also include a title and reference page. The CSU Global Library (Links to an external site.) is a good place to find these references. Review the grading rubric to understand how you will be graded on this assignment. Reach out to your instructor if you have questions about the assignment. Submit your written assignment to the Dropbox in Canvas.

Answer 1

​​​​​​Accounting Ratios:-

Ratios shows the relationship between two figures expressed in mathematical terms. where as ratio analysis is the study of relationship between various items or groups of items in financial statements

The objectives of ratio analysis is to locate the sports of business which need more attention 2 To provide deeper analysis of the profitability and financial position of the business 3To provide information useful for making estimates and preparing the plans for the future.

Uses of accounting Ratios:-

1) helpful in analysis of financial statement

2) simplification of accounting data

3) helpful in comparative study

4) study of financial soundness

5) helpful in forecasting

CLASSIFICATION OF RATIOS

1. Liquidity ratio:- this ratio are used to assess the short term financial position of the concern business. They indicates the firm's ability to meet its current application out of current resources that's why this ratio is also called as short term solvency ratio. Liquidity ratios include two ratios:. 1) current ratio on working capital ratio. 2) quick ratio or acid test ratio or liquid ratio.

1) Current ratio on working capital ratio: this ratio explains the relationship between current assets and current liabilities of a business. The formula for calculating the ratio is:- Current Ratio= current assets/current liabilities
current assets includes those assets which can be converted into cash within a year and current liabilities include those liabilities with the payable in year.
Significance of current ratio: this ratio is used to assess the firm's ability to meet its short term liability on time. According to accounting principles a current ratio of 2:1 is supposed to be an ideal ratio.the higher the ratio the better it is because the firm will be able to pay its current liability more easily.
From the viewpoint of management a much higher ratio may be considered to be adverse as a much higher ratio indicates that inventory might be piling up because of poor sales and large amount is locked up in tray disabled due to inefficient collection policy and the cash or bank balance might be line idea because of no proper investment opportunities are available.

2) Quick ratio or acid test ratio or liquid ratio:- it indicates whether the firm is in a position to pay its current liabilities within the month or immediately. As such the quick ratio is calculated as by dividing liquid assets by current liabilities.

Quick ratio or acid test ratio= Liquid assets/current liabilities. *Liquid assets= current assets - inventories - prepaid expenses

Ideal ratio is 1:1

Significance: this ratio is a better test of short term financial position of the company as it consider only those assets which can be easily and readily converted into cash.when this ratio used together with current ratio it gives a better picture of the short term financial position of the firm.

Illustration:

Solution: 1) Liquid ratio= Liquid assets/current liabilities

Liquid assets= cash + trade receivables.(100000+2400000)2500000

Current liabilities=trade payables (2500000)

Hence, Liquid ratio=2500000/2500000=1:1

2) Current Ratio= current assets/ current liabilities

Current assets=liquid assets + inventory (2500000+900000)

Current liabilities=2500000

Hence current Ratio=3400000/2500000 =1.36:1

Comment: in this case current ratio is 1.36:1 which is less than the ideal ratio therefore it can be said that the company's shorter financial position is not satisfactory. The ideal quick ratio 1:1.

2. Solvency ratio:-

a)Debt equity ratio- this is to express the relationship between long term debts and shareholder funds. This ratio is calculated to ascertain the soundness of the long-term financial policies of the firm. the debt equity ratio is calculated as Debt equity ratio-long term debts/shareholders funds or net worth

Significance: this ratio is calculated to assess the ability of a firm to meet its long term liability. Generally debt equity ratio of 2 : 1 is considered safe.the lower the ratio the better it is for long-term land is because they are more secure in that case.

b) total assets to debt ratio:-this ratio is a variation of the debt equity ratio and gives the same indication as the debt equity ratio in this ratio total assets are expressed in relation to long-term debts it is calculated as:- Total Assets/Long term debt. this issue is usually expressed as a pure ratio that is 1:1or2:1

Significance:please Asia express the relationship between total Assets and long-term that's it measures the extent to which loan that are covered by assets which indicates the margin of safety available to providers of long term loans.

c) Proprietary ratio:- this ratio indicates the proportion of total assets funded by owner or shareholder it is calculated as under:- equity/total assets or shareholders funds/total assets

Significance: a higher proprietary ratio is generally treated and indicator of sound financial position from long-term point of view because it means that a large proportion of total asset is provided by equity and has the form is less dependent on external sources of finance.

d)Interest coverage ratio:- this ratio is also termed as step service ratio this ratio is calculated by dividing the profit before charging interest and income tax by fixed interest charges. Interest coverage ratio= profit before charging interest and income tax/fixed interest charges

Significance: and interest coverage ratio of six to seven times is considered appropriate it was only gets the extent to which the profit can decline without in any way affect in the firm's ability to meet its fixed interest obligations.

Illustration The following particulars are extracted from the balance sheet of goodwill enterprises limited as at 31st March 2020:

Equity share capital=₹300000

10% preference share capital=₹120000

Capital reserve=₹60000

Profit and loss balance=₹120000

12% debentures=₹50000

10% mortgage loan=₹150000

Current liabilities=₹280000

Non-current assets=₹480000

Current assets=₹600000

Net profit after interest and tax amount to ₹63000 rate of income tax was 50%

Calculate the following ratios:

Debt equity ratio, Proprietary ratio, interest coverage ratio

Solution: debt equity ratio = debt/equity

Debt=debentures + mortgage loan (50000+150000) 200000

Equity=equity share capital + preference share capital + capital reserves + profit loss balance ( 300000+120000+60000+120000)600000

Debt equity ratio= 200000/600000=.33:1

Comment: this ratio indicates what proportion of funds are provided by the long term dates in comparison to shareholders funds. generally the ratio should not be more than 2 :1 the depth ratio of above company is.33: 1,which indicates that long term debts are .33 in comparison to share holder fund and it may consider that the long-term financial position of the company is very sound.

B) proprietary ratio=equity/total assets

Total assets=non current assets + current assets (480000+600000)1080000

Proprietary ratio = 600000/1080000 = .5556 or 55.56%

Comment: shareholder funds of the company are 55.56% in comparison to total Assets of the company. In other words 55.56% of the total Assets of the company are funded by equity which indicates that the long-term financial position of the company is very sound.

C) interest coverage ratio= net profit before interest and tax/fixed interest charges

Fixed interest charges= 12% interest on debenture of rupees 50000 + 10% interest on mortgage loan of rupees 150000 (6000+15000)21000

Net profit before interest and tax is calculated as follows:

Net profit after interest and tax=63000

Net profit before tax=63000*100/50=126000

Net profit before interest and tax=126000 + fixed interest charge

126000+21000=147000

Interest coverage ratio=147000/21000= 7times.

Reference. Book Accountancy Arya publications by D K Goel, Rajesh Goel, Shelly Goyal.