Question

Describe some ratios that can be calculated using the basic financial statements that will help a decision maker assess the financial position of the government.

Answer 1

Solution:

Financial statement represents a summary of the financial information prepared in the required manner for the purpose of use by managers and external stakeholders. Financial reports are prepared basically to communicate to the external shareholder about the financial position of the company that they own. Assessing the quality of information is an important aspect of financial statement analysis. Ratio analysis is used as a device to analyze and interpret the financial strength of the enterprise. With the help of these ratios financial statements can be analyzed and interpreted more clearly and conclusion can be drawn about the performance of the business.

  

          Following ratios are helpful to assess the financial strength of the company and Government.

1. CURRENT RATIO

          The current ratio shows the relationship between the current assets and current liabilities. The current ratio measures a company's ability to pay off its current liabilities (payable within one year) with its current assets such as cash, accounts receivable and inventories. The higher the ratio, the better the company's liquidity position:

2. QUICK RATIO

          The Quick ratio is similar to the current ratio as it highlights the liquidity of the company. A ratio of 1:1 is satisfactory, if less than one it implies that the company has a large amount of its cash tied up in unproductive asset, so the company may struggle to raise money in the short term.

3. Net working capital Ratio

          The working capital ratio can given an indication of the ability of your business to pay its bill. A stronger ratio indicates a better ability to meet ongoing and unexpected bills. A weaker ratio may indicate that your business is having greater difficulties meeting its short-term commitments and that additional working capital support is required.

GROSS PROFIT MARGIN

This ratio measures the marginal profit of the company. This ratio is also used to measure the segment revenue. A high ratio represents the greater profit margin and it’s good for the company. This ratio may indicate to what extend the selling price of goods per unit may be reduced without incurring loss on operation. If gross profit rate is continuously lower than the average margin means something is wrong.

NET PROFIT MARGIN

This ratio measures the overall profitability of company considering all direct as well as indirect cost. A high ratio represents a positive return in the company and better the company is. A net profit margin of 10% is considered normal. This ratio is very useful to control costs and to increase the sale.

         

Ratios are mathematical calculations that compare one financial statement item with another financial statement item. The two items may come from the same financial statement or from the two different financial statements. Accountants and financial analysts have developed many ratios that place information from a company’s financial statement in a context to permit better understanding to support decision making.