What Do You Mean By Financial Ratio
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Accounting has developer
in the world slowly for thousand years. Accounting is the process of
identifying, measuring and communication financial or economic information to
help decision making to the user. Financial Statement is the formal recode of
the financial data or activities of a business. Analysis of financial statement
helps to identify organizational financial strength and weakness. Financial
ration analysis help management to compare its business performance against
competitor or against own previous performance.
1. What do you mean by
financial ratio? Explain Different Types of Financial Ratio?
2. Answer to the Question
Number 1:
Financial Ratio is numerical
indicator of firm’s performance as well as financial situation. This ratio is
taken from the Financial Statement of the Organization. Financial Ratio can use
by present or potential stakeholder, as well as creditors. Management use
financial ratio to compare the financial performance with its competitor or
performance against previous year. However, Financial Ratio can be state as
decimal value (0.10) or percentage value (10%) (Higgins, 2007).
Most Common Uses of Ratio
(Higgins, 2007):ay is an example of a student's work
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not
To compare performance
over a period of time
To compare performance
against competitor
To compare performance
against a target
To compare performance
against industry average
In addition, Financial
Ratio Analysis is a accounting process which organize accounting and financial
information into structured form which identify companies strengths as well as
weakness. However, use of financial ratio may be helpful but there is a chance
it can direct to information overload because of as many as 44 various ratios
(Higgins, 2007).
Financial Ratio Analysis
can be classified as following way (Elliott, et. al., 2008):
Profitability Ratios
Liquidity Ratios
Dividend Policy Ratios
Asset turnover Ratios
Financial Leverage Ratios
1. Profitability Ratios
Analysis
Profitability ratio
calculates the firm’s use of assets and control of its expenditure to make an
satisfactory rate of return. In addition, it gives the measure of company’s
capability to generate profit. There many types of profitability ratio. Some of
them are given below (Elliott, et. al., 2008):
1.1. Gross profit Margin
1.2. Return on Assets
1.3. Return on Equity
2. Liquidity Ratio Analysis
Liquidity Ratio Analysis
gives information about thy firm’s capability to meet its short-term financial
Debts or Obligations. Two most common liquidity ratio is Current and quick
ratio (Elliott, et. al., 2008).
2.1. Current Ratio
2.2. Quick Ratio
3. Dividend Policy Ratio
Dividend policy ratio
gives the insight of the dividend policy of the organization and the
probability of future growth. Two most common dividend policy ration are payout
ratio and Dividend yield.
3.1. Dividend Yield
3.2 Payout Ratio
4. Asset Turnover or
Efficiency Ratio
It indicates how
effectively or efficiently companies use its assets (Elliott, et. al., 2008).
4.1. Inventory Turnover
4.2. Inventory Period
4.3. Receivables Turnover
4.4 Average collection
period
5. Financial Leverage
Ratio
It gives firm a indication
of long term solvency, financial leverage ratio measure the area about how
the company using its long term debt (Elliott, et. al., 2008).
5.1. Debt Ratio
5.2. Interest coverage
5.3. Debt-to-Equity Ratio
All ratios are subject to
the limitation of the accounting method, different accounting method chooses
may gives different value of ratio.
2. A. Describe the double
entry book keeping system.
3. Answer to the Question
Number 2.A:
All accounting Data were
kept in book manually from about hundred years ago. So the process of recording
accounting data is often called bookkeeping. Therefore, Bookkeeping is the
practice of recoding accounting data or transaction in the accounting Books. In
1494, Italian merchant Lucas Pacioli wrote the first book about Double Entry
Bookkeeping System. The main base of Double entry Book-keeping system is
recording the data having two fundamental aspects, (giving and receiving),
first one is receiving the benefit and other one is giving the benefit in the
same book (Wood et. al., 2008).
However, the person or
party or received the benefit is called Debtor (Dr) and one who gives the
benefit is called Creditor (Cr). Under the double entry system both receiving
and giving aspects are record in accounting terms. The ultimate result of the
Double entry bookkeeping system is that each debit must have an equivalent
credit and in the specific day total debit entry must be equal to the total
credit entry in the accounting book (Wood et. al., 2008)..
For Example, Company A has
got long term loan for £1000,000 from company B on December 1, as a result
Company A, cash account (Assets) increased by £100,000 and debated for that
amount. On the other hand, the Company’s payable account (Liabilities)
increased also by £100,000 and it is credited. Therefore, Bothe side of the
accounting book are increased by £100,000 and the debits and credits remain
equal (Wood et. al., 2008)..
The main advantage of the
double entry bookkeeping is it is used to draw Trial balance to prove
arithmetic accuracy of record and possible to make profit and loss account from
it. In addition, it is important to make Balance sheet of the organization
(Wood et. al., 2008)..
2. B. Describe the
accounting process in preparation of financial statement.
4. Answer to the Question
Number 2.B.:
Accounting cycle includes
four basic steps, firstly recording the data; secondly, recording the data;
thirdly, adjusting the accounts and finally, prepare financial statements.
Generally, in the accounting period, account recodes the all transaction in the
company as it occurs. Towards month end accountant post adjustment entries to
correct each accounts. After make sure each account is correct, account make a
Trail Balance from the Ledger book and prepare the financial statement (Wood
et. al., 2008).
So, the first step to make
Financial Statement is to make a ledger and from ledger make a Trail balance
and then make the financial statement from Trail balance.
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Logical Order of Preparing
Financial Statement (Wood et. al., 2008):
1. Income Statement of the
Company for a particular period of time
2. Statement of the retain
earnings
3. Balance Sheet of the
Company
4. Cash flow Statement
Figure 1: Financial
Statement process
1. Income Statement
Income statements
generally include company’s revenues, expenditure and outcome is capital gain
or loss. To prepare Income Statement accountant transfer accounting data from
ledger or trail balance to income statement (Wood et. al., 2008).
2. Statement of Retain
Earnings
This statement present the
companies retain earnings for the beginning and the ending accounting period.
The information need to make Retain Earning Statement is following below (Wood
et. al., 2008):
Beginning retain earnings
from the last statement (ending retain earning for the last account period)
Net income or loss from
the income statement
Dividends paid by the
company during this account period
Balance Sheet
Balance Sheet presents the
Assets, liabilities as well as share holder equity of the organization. In is
prepared using the below information (Wood et. al., 2008):
Total Balance of All
Assets (Cash, Account receivable)
Total Balance of all
Liability (Account payable)
Capital share balance
Total retain earnings from
retain earning statement.
4. Cash follow statement
This statement describe
the cause for changes in the cash balance, Cash follow statement cannot be
prepare from ledger rather it is make by modifying actual information to a
cash-basis (Wood et. al., 2008).
3. A. Basic accounting
equation as the basis for the balance sheet
5. Answer to the Question
Number 3.A.:
Assets, equity and
liability are the financial measure of the firms. The financial statement which
presents all this information is called Balance sheet. In addition, Balance
sheet includes Assets, liabilities and shareholder equity of the organization.
The relationship between them can be providing algebraically or commonly known
Accounting Equation. Basic Accounting Equation: Equity = Assets – Liquidity or
Assets = Liabilities + Equity.
This equation means value
of the organizational Assets is equal value to the liabilities plus equity of
the organization (Wood et. al., 2008).
On the other hand, Balance
Sheet of the company has two sections or side, one section represents the value
of the Assets and other section presents the value of liabilities and equity.
The balance of the two side of the balance sheet must be equal as like
accounting basic equation (Assets = Liabilities + Equity) (Wood et. al., 2008).
So we can say that basic
accounting equation is the basis for the Balance Sheet.
3. B. Realization of
revenue and expenses for the income statement.
6. Answer to the Question
Number 3.B.:
Income Statement or Profit
and Loss account (P&L) is the statement which summarize the revenues,
expenditure or cost sustain during a particular period of time, generally a
year or a fiscal quarter. Income Statement presents capability of a company to
create profit by decreasing cost or expenditure and by increasing sales. The
main purpose of the Income Statement is to show the stakeholders and
managements whether the company or organization makes profit or income at a
particular time. The format of the Income Statement differs from company to
company but most company have two main sections such as Revenues and Expenses
(Elliott et. al., 2008);
1. Revenue and Gains
Revenue or Income from
major activities also called operating revenue. It is the revenue from selling
product or service to the customer for wholesaler, retailer and distributors
and manufacturer. Service or Sells revenue shown in the Income statement in the
period they are earned or delivered not on the time of receive receipt (Elliott
et. al., 2008).
Revenue and Income from
minor activities is also shown in Income Statement. These types of revenue
include; interest from primary revenue, sale of long term assets and gains from
law suits (Elliott et. al., 2008).
2. Expenses and Losses
Expenses or also called
expenditure of the company. This is incurring for earnings primary revenue.
Expenses are generally shown in the same period that the related sales to gain
revenues (Elliott et. al., 2008).
Expenses from secondary
activities called non operation expenses such as interest of non operating
expense. Distribution cost, administration cost, research and development cost
also include here (Elliott et. al., 2008).
3. C. Describe the income
statement.
7. Answer to the Question
Number 3. C:
Income Statement is the
part of Financial Statement of the organization. Income Statement or Profit and
Loss account (P&L) is the statement which summarize the revenues,
expenditure or cost sustain during a particular period of time, generally a
year or a fiscal quarter. Income Statement presents capability of a company to
create profit by decreasing cost or expenditure and by increasing sales
(Elliott et. al., 2008).
This essay is an example of a student's work
Disclaimer
The main purpose of the
Income Statement is to show the stakeholders and managements whether the
company or organization makes profit or income at a particular time. The format
of the Income Statement differs from company to company but most company have
two main sections such as Revenues and Expenses (Elliott et. al., 2008);
The main Elements of
Income Statement
Revenue
Expense
Turnover
Sales
Cost of Sales
Gross margin
Operation Profit
Profit before tax
Profit after tax
Retained Profit
8. Conclusion:
Analysis and
Interpretation of the financial statement is the very important for the
business organization success. It helps investor to decide where to invest.
Evaluation the financial ratio analysis management of the organization can
modify necessary change needed to attain the business goal of the organization.
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