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In: Accounting

Determining the financial health of a business involves looking at indicators of the business’ ability to...

Determining the financial health of a business involves looking at indicators of the business’ ability to meet its maturing financial obligations i.e. any bills that have to be paid when they become due.

(a) What are these indicators?
(b) Define the two Liquidity Ratios that are commonly used by financial analysts, properly describing all terms in the definition equation. Why are these ratios important to assess the financial health of a business?
(c) Give examples of healthy values for these ratios, and explain why.

(d) Define the Debt/Equity ratio of a business. What is this ratio generally used for when analysing a business?

Solutions

Expert Solution

(a) A Business's financial health can be determined mainly using some indicators like profitability ratio, liquidity ratio and gearing ratio

(b)Some examples of liquidity ratio are Quick ratio and Trade payable days

Quick ratio is an indicator of company's short term liquidity position and companies ability to meet its short term obligations with its liquid asset

Quick ratio = Current asset -Inventory / Current liabilities

Trade payable days indicates the time taken by the business to pay their payablesThe decreased payable days shows company is paying their bills early which lose the companys liquid cash asset

Trade Payable days = Trade payables / Credit purchase * 365

(c) Healthy value of Quick ratio is 1:1 which indicates equal amount of current asset(except inventory)and current liabilities

Healthy value of payable days are set according to the industry average,payables days varies according to industry

(d) Debt / Equity ratio also known as gearing ratio indicates the gearing level of the company ie, the portion of debt in the capital structure of the company

Commonly used ratios for analysing the business are Price / Earnings ratio (P/E ratio) and Gearing ratio

ekkarill92 answered 2 years ago
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