Business Finance – the financial position of business firms II

Back to: COMMERCE SS2

 

Welcome to Class !!

We are eager to have you join us !!

In today’s Commerce class, We will continue learning about Business Finance. We hope you enjoy the class!

 

 

LIQUIDITY RATIOS:

These ratios help in measuring the ability of an organization to meet its obligations as they fall due. Ratios under this heading are:

1. Current ratio or working capital ratio
2. Average stock
3. Stock to net current assets
4. Debtors ratio
5. Creditors ratio

 

1. CURRENT RATIO OR WORKING CAPITAL RATIO: This ratio indicates the ratio of current assets to current liabilities. It shows the extent the firm can meet up with its short-term creditors. Low ratio implies lack of working capital while high ratio suggests too much of working capital or capital tied up.

$Formula: \frac{Current Assets}{Current Liabilities} = \frac{CA}{CL}$

 

2. ACID-TEST / LIQUID RATIO: This ratio provides measures of the firm’s ability to meet its current liability. Should it fall below 1:1, the firm may have some difficulty in paying its debt.

$Formula: \frac{CURRENT ASSETS – STOCK OR INVENTORY}{CURRENT LIABILITIES}$

 

3. STOCK TURNOVER RATIO: This is used to measure the number of times stocks are replaced during a given period.

$Formula: \frac{COST OF GOODS SOLD}{AVERAGE STOCK}$

 

4. $AVERAGE STOCK : \frac{OPENING STOCK + CLOSING STOCK}{2}$

N.B: Where there is no opening stock, the average stock could be calculated by adding closing stock to purchases and dividing by 2

 

5. STOCK TO NET ASSET. This ratio is used to express the stock as a percentage of net assets.

$Formula: \frac{STOCK}{NET ASSET} \times \frac{100}{1}$

 

6. DEBTORS RATIO: Debtors ratio measures the average collection period from debtors. It shows the average credit period given to debtors.

$Formula: \frac{DEBTORS}{CREDIT SALES} \times 365 DAYS$

Long collection dates indicate poor credit policy.

 

7. CREDITORS RATIO: This ratio shows the average credit period received from suppliers.

$Formula: \frac{TRADE CREDITORS}{CREDIT PURCHASES} \times 365 DAYS$

 

8. GEARING OR LEVERAGE RATIO: This shows the relationship between owners’ equity or capital and debt financing of business assets.  It shows the proportion of the assets being financed with long-term debt.

$Formula: \frac{Long term Liabilities}{Equity Capital}$

 

If the Gearing Ratio is above 40% (0.4) the business is said to be highly geared.  If lower than 40% (0.4) the business is low geared.

 

REVIEW QUESTIONS

1. State two uses of financial ratio.
2. List four liquidity ratios that can be used to evaluate the viability of a business firm.

 

 

READING ASSIGNMENT

Essential Commerce for SSS by O.A Longe page 153-162.

  

THEORY

1. State three uses of the balance sheet prepared by business firms.
2. List four uses of the Trading, Profit and Loss Account prepared by business firms.

 

 

GENERAL EVALUATION QUESTIONS

1. Explain seven roles of transport to businessmen
2. List ten sources of capital available to a public limited company
3. Give seven reasons why consumers need protection
4. State five effects of hire purchase on the buyer
5. State eight reasons why a bank may dishonour a cheque

 

 

 

We have come to the end of this class. We do hope you enjoyed the class?

Should you have any further question, feel free to ask in the comment section below and trust us to respond as soon as possible.

In our next class, we will be learning about The Stock Exchange. We are very much eager to meet you there.

 

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