Podcast
Questions and Answers
What does a current ratio of less than 1 indicate about a business?
What does a current ratio of less than 1 indicate about a business?
Which of the following is excluded from the calculation of the acid test ratio?
Which of the following is excluded from the calculation of the acid test ratio?
If a business has a quick ratio of 1.5, what does this imply?
If a business has a quick ratio of 1.5, what does this imply?
What is a desired ideal current ratio for a business?
What is a desired ideal current ratio for a business?
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How is inventory turnover calculated?
How is inventory turnover calculated?
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What does a high inventory turnover typically indicate about a business?
What does a high inventory turnover typically indicate about a business?
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How is the average inventory calculated?
How is the average inventory calculated?
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What does a net profit margin measure?
What does a net profit margin measure?
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What effect does not collecting debts on time have on a business?
What effect does not collecting debts on time have on a business?
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Which statement about gross profit margin is true?
Which statement about gross profit margin is true?
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Study Notes
Liquidity Ratios
- Ratios assess a business's ability to meet short-term obligations as they arise.
- The current ratio compares total current assets to current liabilities; ideal is 2:1.
- A current ratio below 1 signifies liabilities exceed expected cash-convertible assets, indicating financial risk.
- Liquidity assets, such as cash and receivables, are considered for calculations; inventory and prepayments are excluded.
- A higher liquidity ratio indicates stronger financial health, while a lower ratio suggests potential payment struggles.
- A quick ratio of 1.5 means RM1.50 in liquid assets available for each RM1 current liability, while a ratio below 1 indicates difficulty in meeting short-term debts.
Efficiency Ratios
- These ratios evaluate a business's asset management efficiency in generating revenue.
- Inventory turnover reflects how often inventory is sold and replaced; calculated by dividing cost of sales by average inventory.
- Average inventory is computed as (Opening Inventory + Closing Inventory) / 2.
- A high inventory turnover suggests healthy sales; a rate of 1 or less indicates excess inventory and cash flow risks.
- The collection period measures time taken to collect money from debtors; shorter periods improve liquidity.
Performance Ratios
- Performance ratios illustrate business performance over an accounting period, often shown as gross profit percentage of net sales.
- Gross profit is net sales minus the cost of goods sold; gross profit margin reflects profit after cost of goods sold and before other expenses.
- A gross profit margin of 40% indicates RM60 of costs for every RM100 in sales, leaving RM40 for operating expenses.
- Net profit margin indicates net profit per sales revenue, showing efficiency in managing operating and overhead costs.
- Net profit is derived by subtracting total expenses from net sales; calculated as a percentage of net sales.
- A positive net profit margin reflects strong financial health; high margins suggest efficient management and pricing strategies.
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Description
This quiz covers the concept of current ratios and their significance in assessing a business's ability to meet short-term obligations. Understand the relationship between current assets and current liabilities and learn why an ideal ratio of 2:1 is considered healthy for businesses. Test your knowledge on how these ratios influence financial stability.
