Financial Ratios and Business Valuation: Accounting for Business

This assignment delves into the core concepts of accounting for business, focusing on financial statement analysis and business valuation. Part A involves a comprehensive examination of financial ratios, including current ratio, quick ratio, accounts receivable turnover, and inventory turnover, using provided financial data from 2017 to 2019. It assesses the short-term solvency and efficiency of a business. Part B focuses on identifying and classifying revenue and income items based on their definitions. Part C applies accounting knowledge to real-world scenarios, evaluating the liquidity of two companies for loan approval and valuing businesses using the asset-based approach. The assignment utilizes financial statements, balance sheets, and ratio calculations to provide insights into the financial health and performance of the companies involved, along with references to academic sources.

Running Head: ACCOUNTING FOR BUSINESS 1
Accounting for Business
[Name of Writer]
[Name of Institution]

ACCOUNTING FOR BUSINESS 2
Part A
a.
The ratios are used as a tool to measure various aspects of a business. They help a
stakeholder take best decision in the given circumstances. The following table shows the
calculation of ratios:
Financial Item 2019 2018 2017 Avg
2018
Avg
2019
Net credit sales
630,000 490,00
0
Cost of goods sold
290,000 250,00
0
Cash
18,000 12,000
Accounts receivable
70,000 60,000 78,000 69,000 65,000
Inventory
130,000 150,00
0
130,000 140,000 140,000
Current liabilities
105,000 81,000
Ratio
Current Ratio 2.08 2.74
Quick Ratio 0.84 0.89
Accounts receivable
turnover (Times)
9.69 7.10
Accounts receivable
turnover (Days)
38 51
Inventory Turnover
(Times)
2.07 3.62
Inventory Turnover
(Days)
176 204
a. Current Ratio
The current ratio is an analysis of the ability of a company to pay back the current
liabilities using the current Assets. It reveals the company’s ability to pay back short-term
liabilities. The current ratio of Green Apple Ltd was 2.74:1 in 2018 and it decreased slightly in
2019 and was 2.08:1. The current ratio of 1:1 is considered fine. However, this company is a

ACCOUNTING FOR BUSINESS 3
service-based company, quick ratio will further elaborate the liquidity of Green Apple Ltd
(Gaiardelli, Saccani & Songini, 2007).
Quick Ratio
The Quick Ratio takes only liquid assets, that is the assets those are quickly convertible
into cash, into account. That is to closely analyze the ability of a company to pay back its short-
term liabilities. The quick ratio of Green Apple Ltd was 0.89:1 in 2018 and it fell to 0.84:1 in
2019, The reason for fall of both quick ratio and current ratio is the overall fall in the current
assets from 2018 to 2019. The current assets in 2019 were $4000 less than the current assets of
2018. Whereas the current liabilities rose by $24,000. Hence, both quick and current ratio fell.
Accounts Receivable Turnover
The Accounts receivable turnover means the time taken by the company’s receivables to
pay what they owe to the Green Apple Ltd (Mendoza, 2015). In 2018 the Accounts receivable
turnover was 51 days. Which was very high as compared to normally allowed period to pay off
was 30 days. The company improved its collection probably by strict credit policies, to 38 days.
This is still higher than what ideal turnover should be.
Inventory Turnover
The Inventory turnover reveals how many days a company takes to convert the inventory
bought into sales. The inventory turnover of the service industry is generally higher as they do
not have any merchandise to sell. The inventory turnover of Green Bell Ltd was 204 days in
2018 and it improved and was 176 days in 2019. However, in both years the inventory turnover
of Green Apple Ltd was 103 days higher in 2018 and 75 days higher in 2019. The Green Apple
Ltd must work on their Cost of goods sold as despite the reduction of $20,000 from 2018 to
2019; the cost of goods sold has increased by $40,000.
b. Short Term Solvency and Efficiency of Business
Solvency is defined as the ability of a company to pay back its long-term obligations
(Iyer, Puri & Ryan, 2016). The term short term solvency means the liquidity of a company. The
liquidity is the ability of a company to pay back its short-term obligation. The short-term
solvency of Green Apple Ltd seems to be fine in terms of current ratio. However, the quick ratio

ACCOUNTING FOR BUSINESS 4
is less than 1:1 which is because of too much tied in inventory and mismanagement of inventory
by Green Apple Ltd.
The efficiency of the business means its ability to make best possible use of the available
resources (Neacsu, 2015). Efficient businesses reduce costs and increase output without any
change in the resources at hand. The efficiency of Green Apple Ltd is measured by the inventory
and accounts receivable turnover. The ratios indicated that the business is not very efficient
specially when it comes to the inventory management. In Accounts receivable it is not even
successful in implementing its own credit term of 30 days.
Part B:
The revenue for Green Apple Ltd means that the proceeds received from sales of
products and services during due course of business activities. The Green Apple Ltd has five
foregoing financial items, i.e. The earning from sale of software, Sale of updates of software,
Interest earned from the short-term money market investment, discount on early cash payment
and issuance of shares. Not all these five financial items would meet definition of income. The
Income for Green Apple Ltd is one which is earned from sources apart from mainstream services
provided. The Interest from investment in short term money market of $50,000 is income. As
well as cash discount of $2,000 arising from early settlement of a liability is income for Green
Apple Ltd. That is classified as income because these are not earned by selling the software or
any other service related to it.
There are two transactions of Green Apple Ltd that meet the definition of revenue for the
company. $25,000,000 earned from the sale of software and the $3,000,000 earned from the
downloads of updates. The reason for classification of above mentioned transactions as revenue
is that they are earned because of sale of services the business was formed to deliver.
Part C:
a.
The bank is a stakeholder of the business interested in getting loan. As the banker,
evaluation of liquidity is important before grant of the loan. The Current Ratio of ABC Ltd is
calculated by Dividing the current assets by current liabilities and we get (7200/54000) = 0.13:1.
The current ratio of ABC Ltd Is less than conventional current ratio of 1:1.
The Current Ratio of XYZ Ltd is calculated by Dividing the current assets by current
liabilities and we get (26000/12000) = 2.17:1. XYZ Ltd can pay off its current liabilities with the
available current assets twice. The liquidity state of XYZ Ltd is better than the state of ABC Ltd.
The quick ratio can also be calculated, however, the state of ABC Ltd.’s liquidity will further
worsen. Therefore, Current Ratio is enough to determine the company whose loan application
should be accepted (Falato & Liang, 2016). (Wealth, 2019). After the grant of loan of $6,000 the
current ratio of XYZ Ltd will become (26000/18000) = 1.44:1. The current ratio has the cushion

ACCOUNTING FOR BUSINESS 5
to absorb extra current liabilities. The current ratio after loan grant is still greater than the 1:1.
XYZ Ltd would be able to pay back the current liabilities 1.44 times with the available current
assets. It is important to note that the loan amount in bank account of XYZ Ltd is not considered
for calculation of after loan grant current ratio. Hence, as a banker it will be favorable for the
bank to approve loan application of XYZ Ltd.
b.
The Business valuation is done at time of selling of a business. The business is valued
using the following three approaches
1. Asset based Approach
2. Income based Approach
3. Cash flow based Approach
The ABC Ltd and XYZ Ltd will be valued using the Asset based Approach. The
following table shows their net worth.
ABC Ltd Balance sheet
As at 30 June 2020
XYZ Ltd Balance sheet
As at 30 June 2020
Assets Assets
Current assets Current assets
Cash at bank 2 400 Cash at bank 2 000
Accounts receivable 4 800 Accounts receivable 24 000
Total current assets 7 200 Total current assets 26 000
Noncurrent Assets Noncurrent Assets
Office equipment 6 000 Office equipment 600
land 18 000 land 13 600
building 30 000 building 6 000
Total non-current assets 54 000 Total non-current assets 20 200
Total assets 61,200 Total assets 46200
liabilities liabilities
Current liabilities Current liabilities

ACCOUNTING FOR BUSINESS 6
Accounts payable 21 600 Accounts payable 4 800
Loan payable due 30
September 2020 31 200 Loan payable due 30
September 2020 7 200
Total current liabilities 52 800 Total current liabilities 12 000
Total liabilities 52,800 Total liabilities 12000
Net assets 8 400 Net assets 34 200
Owner’s equity Owner’s equity
P. Cable Capital 8 400 P. Cable Capital 34 200
Total owners’ equity 8,400 Total owners’ equity 34200
Value of Business 16,800 68,400
The formula used to value the both businesses is as follows:
Total Assets -Total Liabilities + Total owner’s Equity
The worth of ABC Ltd is $16, 800 and XYZ Ltd is $68, 400. As a business person XYZ
Ltd can be bought for at a higher price. The liabilities of the company are also taken over; hence,
they are deducted in calculating the value of the business. The total assets of XYZ Ltd are
$15,000 less than those of ABC Ltd. However, the liabilities of XYZ Ltd are $12,000 whereas
liabilities of ABC Ltd are $52,800. That is what reduced the value of ABC Ltd. Another
contributor of the high price of XYZ Ltd was the owner’s equity which was $25,800 more than
that of ABC Ltd.
c.
If the existing owners agree to take on the liabilities the value of businesses would
change. The worth of ABC Ltd will be $69, 600 and the value of XYZ Ltd will be $80,400. The
decision of buying XYZ Ltd would not change as the value of XYZ Ltd is still higher than the
ABC Ltd.’s value. The high equity of XYZ Ltd resulted in a higher value. However, the amount
to be paid to purchase would increase to $80,400 instead of $64, 800.

ACCOUNTING FOR BUSINESS 7
References
Gaiardelli, P., Saccani, N. and Songini, L., 2007. Performance measurement of the after-sales
service network—Evidence from the automotive industry. Computers in Industry, 58(7), pp.698-
708. https://www.sciencedirect.com/science/article/pii/S0166361507000747
Mendoza, R.R., 2015, January. An empirical analysis of financial performance of micro, small,
and medium enterprises in the Philippines. In Global Conference on Business & Finance
Proceedings (Vol. 10, No. 1, p. 192). Institute for Business & Finance Research.
https://www.researchgate.net/profile/Jorge_Restrepo-Morales/publication/
295920764_Flujos_Turisticos_en_Colombia_Perspectivas_y_Determinantes/links/
56d0e08e08ae059e375d4d60/Flujos-Turisticos-en-Colombia-Perspectivas-y-
Determinantes.pdf#page=220
Iyer, R., Puri, M. and Ryan, N., 2016. A tale of two runs: Depositor responses to bank solvency
risk. The Journal of Finance, 71(6), pp.2687-2726. Data retrieved from
https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12424
Neacsu, N.A., 2015. Implementation of ISO 22000-a tool to increase business efficiency and
customer satisfaction. A Case Study: SC Prodlacta Brasov. Bulletin of the Transilvania
University of Brasov. Economic Sciences. Series V, 8(2), p.105.
http://webbut.unitbv.ro/BU2015/Series%20V/BILETIN%20I/14_Neacsu%20A.pdf
Falato, A. and Liang, N., 2016. Do creditor rights increase employment risk? Evidence from loan
covenants. The Journal of Finance, 71(6), pp.2545-2590.
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.474.3257&rep=rep1&type=pdf