Business resources P6

Last year

£192.000/£120.000

Answer = £1.6

This means that for every £1 of current liabilities the business has £1.60 of current assets available. Normally it should between £1.5 – 2. A figure less than 1.5 indicates that the business may experience difficulties in meeting its short-term debts. A figure more than 2 indicates that the business may be holding cash in an unproductive and unprofitable form, it may better use elsewhere.

The business was financially healthier last year than this year. This because the business had £1.60 of current assets to pay it current liabilities last year, but only had £1.53 of current asset to pay for it current liabilities this year. Therefore, this indicates that the business was in better financial position last year.

Acid test ratio

Formula

Current asset – stock/ current liabilities

Working out – £200,000 – £22,000/130

Answer = £1.37

This means that for every £1 of current liabilities the business has £1.37 of current asset available at short notice. Normally the answer should between £1 – 2. A figure less than £1 indicate that the business may experience difficulties in meeting it short-term debts. A figure more than 2 indicates that the business may be holding cash in an unproductive and unprofitable form, it may better use elsewhere.

The purpose of these accounting ratios is to explain the financial information of the business. Accounting ratio helps monitor a business’s performance and will help a business determine profitability. The accounting ratio will help the business analyze their performance. Accounting ratio will help the business see if they are managing their resources well. Current ratio will help the business know quickly they can pay it creditors. A business can only become solvent if they can pay their debts when they become due. This simply means a business can pay its creditors by possessing enough working capital. The acid test ratio helps the business know how quickly it can pay it creditors by deducting the stock. The acid test ratio is more accurate than the current ratio in terms of liquidity. This is simply because the acid test ratio deducts the value of stock from the current assets.  For a business to be able to turn stock into cash could take some time as cash from any sale will only be received according to the business trading agreements. For example, a business may look healthy using the current ratio, but may be carrying too much stock. Margin of safety will help the business whether they are able to break even and see the percentage that they surpass the breakeven point.