Accounting for Business: Financial Ratio Analysis & Solvency

This report provides a detailed financial analysis of a business, focusing on key accounting ratios such as the current ratio, quick ratio, accounts receivable turnover ratio, and inventory turnover ratio. It analyzes the company's solvency and efficiency based on these ratios, comparing data from 2018 and 2019. The report also discusses the AASB conceptual framework of accounting, specifically regarding income, revenue, and gains. Furthermore, it evaluates the financial positions of two companies, ABC and XYZ Limited, using ratios like current ratio, quick ratio, and debt-equity ratio, to determine which would be a better loan candidate or acquisition target, considering net asset value and liabilities. This student contributed assignment is available on Desklib, where students can find similar resources and study tools.

ACCOUNTING FOR BUSINESS 1
ACCOUNTING FOR
BUSINESS

ACCOUNTING FOR BUSINESS 2
Contents
Part A:...........................................................................................................................3
Sub part a:.................................................................................................................3
Sub part b:.................................................................................................................4
Part B:...........................................................................................................................5
Part C:...........................................................................................................................5
Sub part a:.................................................................................................................5
Sub part b:.................................................................................................................6
Sub part c:.................................................................................................................7
References...................................................................................................................8

ACCOUNTING FOR BUSINESS 3
Part A:
Sub part a:
The current ratio is the ratio which is also known as the working capital ratio. This helps in
the measurement of the capability of the business. It helps in the determination of the fact
whether the company would be able to meet its short term liabilities that are due within a
period of 1 year. This ratio helps in considering the weight of the current assets and the
weight of the current liabilities. It helps in the determination of the financial health of the
company and the way in which the liquidity of the current assets could be maximised so
that the debt and the payables could be settled (Corporate finance institute, 2019).
The quick ratio is also known as the acid test ratio which helps in the measurement of the
ability of the company to meet its short term liabilities. And also determines the
convertibility of assets into cash. These are cash, marketable securities etc. (Corporate
finance institute, 2019).
The accounts receivables turnover ratio is the ratio which helps in the determination of
efficiency that helps in ascertaining the number of times, the business could turn the
accounts receivables into cash. In other words, it shows the number of times, the business
is able to collect the average accounts receivables during the period (Accounting course,
2019).
Inventory turnover ratio is the ratio that helps in the management of inventory in the most
efficient manner. This ratio shows the number of times, the inventory could be concerted
into sales during the year (Accounting course, 2019).
The following table shows the calculated ratios:
Particulars 2019 2018
Current ratio:
2.0761904
8
2.7407407
4
Current Assets
2,18,000.0
0
2,22,000.0
0
Current Liabilities
1,05,000.0
0
81,000.0
0
Quick ratio:
0.8380952
4
0.8888888
9
Current Assets-
inventories
88,000.0
0
72,000.0
0
Current Liabilities
1,05,000.0
0
81,000.0
0
Accounts receivables
ratio:
9.6923076
9
7.1014492
8
Credit sales
6,30,000.0
0
4,90,000.0
0

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Average receivables
65,000.0
0
69,000.0
0
Inventory turnover
ratio:
2.0714285
7
1.7857142
9
Cost of goods sold
2,90,000.0
0
2,50,000.0
0
Average inventory
1,40,000.0
0
1,40,000.0
0
From the above table, it could be seen that the current ratio has undergone a decrease.
This is due to the decrease in both the current assets and current liabilities. Though the
ratio of the company is above the ideal ratio but a decrease in ratio could mean problems
to the liquidity position of the company.
The quick ratio has undergone a decrease. This is due to the decrease in both the current
assets and current liabilities. Though the ratio of the company is above the ideal ratio but a
decrease in ratio could mean problems to the liquidity position of the company.
The accounts receivables ratio shows an improvement when compared with the previous
year of 2018. This increase is due to both an increase in the amount of the credit sales
and the average accounts receivables. This means that the management of the company
is effective enough to generate sales and improve its financial position.
The inventory turnover ratio has improved. This is due to an increase in the amount of the
both the cost of goods sold and average inventory. This means that the management is
working efficiently. This could be seen from the increase in the number of times the
average inventory could be converted into sales.
Sub part b:
In respect of the solvency of the company, the current ratio and the quick ratio would be
considered. From the above, it could be said that though the ratios calculated are above
the ideal ratios but a decrease could hinder the liquidity position of the company in the
future. Hence, it’s alright if the ratio has decreased during the current year but the
company must ensure that this decrease does not go any further.
In respect of the efficiency of the company, the calculated ratios shows an increase which
is good for the company. An increase would mean efficiency on the part of the
management. It should further keep on working towards the increase in the amount of the
sales and improving efficiency.
Part B:
As per the AASB conceptual framework of accounting, the definition of the term income
includes both the revenue and gains. Revenue arises when the company undertake the
different business transactions in the ordinary course of the business. The examples
include sales, fees, interest, etc.
The gains on the items shows the way in which the income meets the definition of gains
and this may not usually arise during the regular course of the business activities of the
company. These indicate the increase in the amounts of the economic benefits and is in

ACCOUNTING FOR BUSINESS 5
no way different from revenue. It is due to this reason that gains are not considered to be
different from revenue in the conceptual framework of accounting (AASB online, 2019).
The following are the relevant classifications:
 Sale of software worth of $250,000 would be considered to be sales or revenue or
income since it is in the regular course of business transactions
 Update downloads worth of $3000,000 would be considered to be sales or revenue
or income since it is in the regular course of business transactions
 $50,000 as interest from investing in short term money would be considered as
“Other income” since it is in the regular course of business transactions
 Issue of shares of $500,000 is not a revenue nor an income since it is not in the
regular course of business transactions
 $2,000 discount on account of early settlement is not revenue or an income since
this is not in the ordinary course of business transactions
The following would form the part of revenue due to the reason that they are in the regular
course of business transactions and forms the part of day to day functioning of the
company:
 Sale of software
 Update downloads
 Interest from investing in short term money
Part C:
Sub part a:
The following table shows the calculated ratios for the purposes of lending:
Particulars ABC XYZ
Current ratio: 0.136363636 2.166666667
Current Assets
7,200.
00
26,000
.00
Current Liabilities
52,800.
00
12,000
.00
Quick ratio: 0.136363636 6
Current Assets-
inventories
7,200.
00
72,000
.00
Current Liabilities
52,800.
00
12,000
.00
Debt equity ratio: 6.285714286 0.350877193
Debt
52,800.
00
12,000
.00
Equity
8,400.
00
34,200
.00

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Loan payable
31,200.
00
7,200
.00
Though, many ratios are calculated for the purposes of the above, but since there is a
limitation of the data available, we have considered only the 3 ratios:
On the basis of the above, it would be better to give loan XYZ Limited due to the following
reasons:
 It has a higher current ratio which means a better liquidity position
 It has a higher quick ratio which means a better liquidity position
 A lower debt equity ratio which means an exposure to lower amount of risk
Any bank before considering the loan application would consider the ability of the company
to repay its loan along with interest, hence a lower liquidity position would mean low ability
of the company to repay.
Sub part b:
Any business is always taken over its net assets value. The following table shows the
relevant calculations:
Particulars ABC XYZ
Net assets
8,400.
00
34,200
.00
Since, the company XYZ Limited has a higher net assets value, it would be better to take it
over. And at the above stated values. On the basis of that, it would be better to take over
or acquire or purchase XYZ Limited due to its higher value of the net assets.
Sub part c:
The following table shows the relevant calculations:
Particulars ABC XYZ
Net assets
8,400.
00
34,200
.00
Add: Liabilities payable
by company
52,800.
00
12,000
.00
Max consideration that
could be offered
61,200.
00
46,200
.00
If the existing companies decide to pay off its liabilities themselves, then the maximum
amount of consideration that could be offered for the purchase would also increase. On
the basis of that, it would be better to take over or acquire or purchase ABC Limited due to
its higher value of the net assets.

ACCOUNTING FOR BUSINESS 7

ACCOUNTING FOR BUSINESS 8
Bibliography
Framework for the Preparation and Presentation of Financial Statements, 2019 [online],
viewed on 15 May 2019 Available at:
https://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPjun14_07-
14.pdf
Current Ratio Formula - Examples, How to Calculate Current Ratio, viewed on 15 May
2019 Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/
current-ratio-formula/
Quick Ratio - A Short Term Liquidity Metric, Formula, Example. [online], viewed on 15 May
2019 Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/
quick-ratio-definition/
Accounts Receivable Turnover Ratio | Formula | Analysis | Example. [online], viewed on
15 May 2019 Available at: https://www.myaccountingcourse.com/financial-ratios/accounts-
receivable-turnover-ratio
Inventory Turnover Ratio Formula | Example | Analysis. [online], viewed on 15 May 2019,
Available at: https://www.myaccountingcourse.com/financial-ratios/inventory-turnover-ratio