Interpretation of financial statements and accounting ratios.

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    This chapter is basically about learning the definitions and the formulas of the respective ratios. These ratios and the financial statements you learnt about in the previous chapters can be used to compare 2 or more businesses , let’s say, to decide which one to buy when you’re about to buy a business and are given couple of choices.

    Gross margin: gross profit x  100%

    Sales

    Rate of stock turnover:

     

     

     

    Lesser the rate of stock turn over, slower the business would be.

     

     

    Accounting ratios can only be used if the nature of businesses is the same and the time period of comparison is the same.

    Liquidity ratios

    Current ratio : the comparison between assets which will become liquid within next 12 months with the liabilities which will be due to be paid within the next 12 months. This ratio is used to find out whether there are sufficient  current assets to meet the liabilities.

     

     

    Acid test ratio

     

    No matter how successful a business apparently is, it may fail if it is not sufficiently liquid.

     

    Debtor to sales ratio

     

    The more money is tied up with debtors, the weaker the business would be.

    Creditor purchase ratio

    Shows how efficient our business is in terms of payment.