Study "ACF RATIOS", a flashcard deck on FORKSAI.
Define the working capital ratio and explain what information it provides to a business.
The working capital ratio is calculated as current assets divided by current liabilities. It provides information on a business's ability to meet its financial commitments over a 12-month period, indicating its short-term liquidity.
Explain the significance of the quick asset ratio for a business's immediate financial health.
The quick asset ratio examines a business's liquidity in the immediate short term, typically over 90 days, by using only the most liquid assets. It provides insight into the ability to meet urgent financial commitments without relying on inventory or prepaid expenses.
Compare and contrast the working capital ratio and the quick asset ratio in terms of their scope and the assets they consider.
The working capital ratio assesses liquidity over a 12-month period, considering all current assets. In contrast, the quick asset ratio focuses on immediate short-term liquidity (90 days) and excludes inventory and prepaid expenses from current assets, as they are less liquid.
Define the gearing ratio and explain what information it conveys about a business's financing structure.
The gearing ratio indicates how a business has financed its assets. It reveals the extent to which a business relies on external debt (liabilities) versus capital contributions from its owners. A high gearing ratio suggests a greater reliance on debt.
Explain why an excess of external debt, as indicated by the gearing ratio, might be a concern for a business.
An excess of external debt, shown by a high gearing ratio, means a business has a significant reliance on liabilities. This can be a concern because it may lead to higher interest payments, increased financial risk, and potential difficulties in securing further financing.
How does the calculation of the quick asset ratio differ from the working capital ratio in terms of current assets?
The quick asset ratio subtracts inventory and prepaid expenses from current assets before dividing by current liabilities (minus bank overdraft). The working capital ratio simply divides total current assets by total current liabilities.
Describe how liquidity ratios, in general, provide information to a business.
Liquidity ratios generally provide information on the ability of a business to meet its financial commitments as they fall due. They help assess the short-term financial health and solvency of the business.
MCQ-STYLE: Which of the following best describes the primary purpose of liquidity ratios?
A
MCQ-STYLE: What is the formula for the working capital ratio?
B
MCQ-STYLE: Which ratio specifically examines liquidity in the immediate short term (90 days)?
C