Syllabus C. ANALYSING AND INTERPRETING THE FINANCIAL STATEMENTS C2. Interpretation of accounting ratios

C2abcd. Liquidity 3 / 4

Syllabus C2abcd)

a) Define and compute relevant financial ratios

b) Explain what aspects of performance specific ratios are intended to assess.

c) Analyse and interpret ratios to give an assessment of an entity’s/group’s performance and financial position in comparison with:

i) previous period’s financial statements
ii) another similar entity/group for the same reporting period
iii) industry average ratios.

d) Interpret financial statements to give advice from the perspectives of different stakeholders.

Current ratio

Quick Ratio

Bank Account / Overdraft

Don't forget the obvious and look at the movement on this

  • Look for why it has increased or decreased

  • If money is spent on assets thats normally a good thing

  • If money is spent on high dividends (with little cash) thats a bad thing

  • If a loan is paid off - that's normally a bad idea (as the company should be able to make a better return)

Working Capital Cycle

This is made up of

The difference between being paid needs to be funded (often by an overdraft)

  1. Inventory Days + (ideally these are low)

  2. Receivable days - (ideally these are low)

  3. Payable days (ideally these are high)

Indicators of deteriorating liquidity

  • Cash balances falling

  • New share / loan issues with no respective increase in assets

  • Sale and leaseback of assets

  • Payables days getting longer