The Financial Position of Business Firms

Determination of Business Viability To ascertain the viability of a business, an examination of the following information sources is imperative: Trading, Profit, and Loss Account. Balance Sheet. Annual Reports of Limited companies. Stock Exchange Reports pertaining to quoted companies. Financial Ratios prepared by accountants and investment analysts.   Balance Sheet A firm’s Balance Sheet provides […]

Determination of Business Viability

To ascertain the viability of a business, an examination of the following information sources is imperative:

  1. Trading, Profit, and Loss Account.
  2. Balance Sheet.
  3. Annual Reports of Limited companies.
  4. Stock Exchange Reports pertaining to quoted companies.
  5. Financial Ratios prepared by accountants and investment analysts.

 

Balance Sheet

A firm’s Balance Sheet provides a concise snapshot of its financial position at a specific date, typically at the end of the financial year.

 

Structure of The Balance Sheet

The conventional balance sheet presents capital and liabilities on the left-hand side and assets on the right-hand side. A sample illustration is provided below:

 

Uses of Financial Ratios

Financial ratios serve various purposes, including:

  1. Preparing industrial averages.
  2. Interpreting financial statements.
  3. Comparing performances among related organizations.
  4. Measuring the ability of an entity to meet short-term obligations.
  5. Evaluating the performance of companies in the same business.

 

Disadvantages of Using Ratios

Despite their utility, ratios have drawbacks such as susceptibility to inflation, potential manipulation, and the impact of different accounting policies.

 

Types of Ratios

  1. Profitability and efficiency ratio
  2. Liquidity ratio
  3. Investment ratio

 

Profitability And Efficiency

Profitability and efficiency ratios gauge management effectiveness in terms of returns on sales and invested capital, including metrics like net profit%, gross profit%, returns on capital employed, assets turnover ratio, and individual expenses items to sales ratio.

 

Liquidity Ratios

Liquidity ratios assess an organization’s ability to meet its obligations. Key ratios include:

  1. Current ratio or working capital ratio
  2. Acid-test/liquid ratio
  3. Stock turnover ratio
  4. Stock to net asset
  5. Debtors ratio
  6. Creditors ratio

 

Gearing or Leverage

The gearing or leverage ratio reveals the relationship between owners’ equity and debt financing of business assets, indicating the proportion of assets financed with long-term debt. If the gearing ratio exceeds 40%, the business is considered highly geared; if below 40%, it is deemed low geared.

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