Company Accounts and Analysis of Financial Statements Questions with Answers
Categories: Freshers Intermediate class NCERT Accountancy
Accountancy Class 12th
Company Accounts and Analysis of Financial Statements Questions with Answers
Q1: What do you mean by Ratio Analysis?
Answer: Ratio Analysis is a technique of financial analysis. It describes the relationship between various items of Balance Sheet and Income Statements. It helps us in ascertaining profitability, operational efficiency, solvency, etc. of a firm. It may be expressed as a fraction, proportion, percentage and in times. It enables budgetary controls by assessing qualitative relationship among different financial variables. Ratio Analysis provides vital information to various accounting users regarding the financial position and viability and performance of a firm. It also lays down the basic framework for decision making and policy designing by management.
Q2: Who are the users of financial ratio analysis? Explain the significance of ratio analysis to them?
Answer: The users of financial ratio analysis are as follows:
- Investors
- Management
- Short term Creditors
- Long term Creditors.
The following points signify the importance of ratio analysis for these users.
- Investors- The main concern for the investors is the security of the funds invested by them in the business and returns on their investments. The security of the funds is directly related to the profitability and operational efficiency of the business. Consequently, they are interested in knowing Earnings Per Share, Return on Investment and Return on Equity.
- Management- They uses ratio analysis to determine how effectively the assets are being used. They are interested in future growth and prospects. They design various policy measures and draft future plans. Consequently, they are interested in Activity Ratios and Profitability Ratios like, Net Profit Ratio, Debtors Turnover Ratio, Fixed Assets Turnover Ratios, etc.
- Short-term Creditors- Short-term creditors are interested in timely payment of their debts in short run. Consequently, they are interested in Liquidity Ratios like, Current Ratio, Quick Ratios etc. These ratios reveal the current financial position of the business.
- Long-term Creditors- Long-term creditors provide funds for more than one year, so they are interested in long term solvency of the firm and in assessing the ability of the firm to pay timely interests. Consequently, they are interested in calculating Solvency Ratios like, Debt-Equity Ratio, Proprietary Ratio, Total Assets to Debt Ratio, Interest Coverage Ratio, etc.
Q3: What are the various types of ratios?
Answer: Accounting ratios are classified in the following two ways.
- Traditional Classification
- Functional Classification
Traditional Classification: This classification is based on the financial statements, i.e. Profit and Loss Account and Balance Sheet. The Traditional Classification further bifurcates accounting ratios on the basis of the accounts to which the elements of a ratio belong. On the basis of accounts of financial statements, the Traditional Classification bifurcate accounting ratios as:
- Income Statement Ratios: These are those ratios whose all the elements belong only to the Trading and Profit and Loss Account, like Gross Profit Ratio, etc.
- Balance Sheet Ratios: These are those ratios whose all the elements belong only to the Balance Sheet, like Current Ratio, Debt Equity Ratio, etc.
- Composite Ratios: These are those ratios whose elements belong both to the Trading and Profit and Loss Account as well as to the Balance Sheet, like Debtors Turnover Ratio, etc.
Q4: What are liquidity ratios? Discuss the importance of current and liquid ratio.
Answer: Liquidity ratios are calculated to determine the short-term solvency of a business, i.e. the ability of the business to pay back its current dues. Liquidity means easy conversion of assets into cash without any significant loss and delay. Short-term creditors are interested in ascertaining liquidity ratios for timely payment of their debts. Liquidity ratio includes
- Current Ratio
- Liquid Ratio or Quick Ratio
Q5: What relationships will be established to study of Inventory Turnover?
Answer: Inventory Turnover Ratio: This ratio is computed to determine the efficiency with which the stock is used. This ratio is based on the relationship between the cost of goods sold and the average stock kept during the year.
Q6: How would you study the solvency position of the firm?
Answer: The solvency position of a firm is studied with the help of the Solvency Ratios. Solvency ratios are measures of the long-term financial position of the firm in terms of its ability to pay its long-term liabilities. In other words, the solvency of the firm is measured by its ability to pay its long-term obligation on the due date. The long-term obligations include payments of principal amount on the due date and payments of interest on a regular basis. The long-term solvency of any business can be calculated on the basis of the following ratios.
Q7: Why would the inventory turnover ratio be more important when analysing a grocery store than an insurance company?
Answer: Grocery store is a trading concern and involved in business of buying and selling of grocery. It keeps stock of various groceries to meet the requirement of the customers and it should calculate the inventory turnover ratio. Hence, this ratio is more important for a grocery store then it is for an insurance company as the latter does not need to maintain any stock of goods sold. The insurance company is engaged in delivering service that is intangible and, thus, cannot be stored.
Q8: What are important profitability ratios? How are they worked out?
Answer: Profitability ratios are calculated on the basis of profit earned by a business. This ratio gives a percentage measure to assess the financial viability, profitability and operational efficiency of the business. The various important Profitability Ratios are as follows:
- Gross Profit Ratio
- Operating Ratio
- Operating Profit Ratio
- Net Profit Ratio
- Return on Investment or Capital Employed
- Earnings per Share Ratio
- Dividend Payout Ratio
- Price Earnings Ratio