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Interpretation of Accounts - Assignment Example

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Interpretation of Accounts

It is here that the various financial ratios come handy in describing the status of the company. The company’s performance can be judged from several accounting and profitability ratios such as liquidity measurement ratios, profitability ratios, debt ratios. The ratios give information about the company’s health and help in decision making to investors, creditors, job seekers and other stakeholders. The company’s current status can also be judged by comparing them with previous years’ financial data or ratios to arrive at the conclusion how the company is faring. Advantages and Limitations of the Financial Ratios On advantage side, it helps read and simply the financial statements. The companies in the same group can be compared with each other. It also helps to understand the trend when compared with the previous years’ financial data. By going through a few numbers, one can quickly assess about the status of the company. On limitations side, it cannot explain the difference between two companies from two different industries or groups. It cannot provide correct information when two different accounting standards are followed, for example, USGAAP and UK accounting standards (Accounting Explained, 2012). Having realized the importance of various financial ratios, it would be now most appropriate to do some ratio analysis for Pompomi. Financial Performance of Pompomi Financial Performance of Pompomi can be judged from several accounting and profitability ratios (Financial Ratios, 2012). Current assets as at 31/09/09 ?195,700 Current liabilities as at 31/09/09 ?43,500 Current Ratio = Current Assets / Current Liabilities = 195,700/ 43,500 = 4.50 Acid-test Ratio Acid-test ratio, also known as the quick ratio, takes into account the most liquid current assets that are available to cover current liabilities. It excludes the raw material stock, finished goods inventory or other current assets that cannot be quickly converted to cash. Acid-test ratio = (Accounts receivable + Cash and Equivalents) / Current Liabilities Given, Current liabilities as at 31/09/09 ?43,500 Cash at bank ?20,000 Cash in Hand ?26,500 Accounts Receivable ?100,000 Thus, Acid-test ratio = (100,000 + 26,500+20,000) / 43,500 = 3.37 It is true that higher the quick ratio, the better it is for the company as it is an indication of liquidity to cover the current liabilities. Acid-test ratio is a conservative measurement of company's current liquidity. If the current ratio and acid-test ratio are very close then it is an indication that the company's current assets are not dependent on inventory. However, if the accounts receivables take considerable time to recover (several months instead of several days) then acid-test ratio can certainly mislead the people regarding its quickness to provide liquidity. In this perspective, it becomes essential to know about the average time taken by debtors to pay the money they owe to the company for their finished goods purchases. Debt to Equity Ratio of Pompomi The debt-equity ratio is a comparison of total debt to total equity of a company. The ratio also gives information about the company's leverage position that in turn, is an indication of the risk profile of the company. Higher debt-equity ratio can be risky during recessionary phase of the business because huge interest outgo may suppress the profit of the company significantly. Even it may cause liquidity issues impacting working of the company. This does not mean that zero debt company is always good. When the company is in growth phase, its fund requirement is huge and that is usually met through raising debts to a reasonable extent. Debt-equity ratio between the industry groups varies widely; it essentially depends upon the nature of business and the growth ...Show more

Summary

Absolute raw data about the company such as revenue generated, profit earned, total capital employed or total debt involved cannot provide any meaningful information unless they are converted in the form that can help make necessary decisions…
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