Question

Q4. (25 marks) Imagine you are planning to raise capital for the firm, you are wary about shareholders, which accounting ratios could address the concerns of those stakeholders regarding efficiency of the assets and cashflow? Explain in detail.

Answer 1

The most cost commonly and top ratios used in the financial field include:

1. Debt-to-Equity Ratio

The debt-to-equity ratio, is a quantification of a firm’s financial leverage estimated by dividing the total liabilities by stockholders’ equity. This ratio indicates the proportion of equity and debt used by the company to finance its assets.

The formula used to compute this ratio is

Total Liabilities / Shareholders Equity

2. Current Ratio

The current ratio is a liquidity ratio which estimates the ability of a company to pay back short-term obligations. This ratio is also known as cash asset ratio, cash ratio, and liquidity ratio. A higher current ratio indicates the higher capability of a company to pay back its debts. The formula used for computing current ratio is:

Current Assets / Current Liabilities

3. Quick Ratio

The quick ratio, also referred as the “acid test ratio” or the “quick assets ratio”, this ratio is a gauge of the short term liquidity of a firm. The quick ratio is helpful in measuring a company’s short term debts with its most liquid assets.

The formula used for computing quick ratio is:

(Current Assets – Inventories)/ Current Liabilities

A higher quick ratio indicates the better position of a company.

4. Return on Equity (ROE)

The return on equity is the amount of net income returned as a percentage of shareholders equity. Moreover, the return on equity estimates the profitability of a corporation by revealing the amount of profit generated by a company with the money invested by the shareholders. Also, the return on equity ratio is expressed as a percentage and is computed as:

Net Income/Shareholder's Equity

The return on equity ratio is also referred as “return on net worth” (RONW).

5. Net Profit Margin

The net profit margin is a number which indicates the efficiency of a company at its cost control. A higher net profit margin shows more efficiency of the company at converting its revenue into actual profit. This ratio is a good way of making comparisons between companies in the same industry, for such companies are often subject to similar business conditions.

ASSETS TURNOVER RATIO

The asset turnover ratio is an efficiency ratio that measures a company's ability to generate sales from its assets by comparing net sales with average total assets. ... For instance, a ratio of . 5 means that each dollar of assets generates 50 cents of sales.

CASH FLOW ON TOTAL ASSETS RATIO:-

Definition: Cash flow on total assets is an efficiency ratio that rates actually cash flows to the company assets without being affected by income recognition or income measurements. The cash flow on total assets ratio is calculated by dividing cash flows from operations by the average total assets.