Theory question 104
Interpretation of Accounts(a) Explain accounting ratio giving one example of liquidity ratio.
(b) State three uses of accounting ratios.
(c) Outline three limitations to the use of accounting ratios.
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(a) An accounting ratio is a figure expressing the relationship between two related items in the financial statements (e.g. current assets to current liabilities), used to assess performance and position. Example of a liquidity ratio: current ratio (current assets ÷ current liabilities) or acid test (quick) ratio.
(b) Any three: measure profitability; assess liquidity/ability to pay debts; assess efficiency of management (stock and debtors turnover); compare performance over years or with other firms; aid forecasting and planning; help lenders and investors decide.
(c) Any three: based on past figures; affected by inflation; different accounting policies hinder comparison; ignore non-money factors; can be window-dressed; no universally ideal ratio; differences in size and industry.
Define, give one liquidity ratio, then three uses and three limits.