Q&A - How does the acid-test ratio differ from the current ratio?
Not all assets can be turned into cash quickly or easily. Some - notably raw materials and other stocks - must first be turned into final product, then sold and the cash collected from debtors. The acid test ratio (sometimes also called the “quick ratio”) therefore adjusts the current ratio to remove the value of stocks from the current assets total. This is because stocks are assumed to be the most illiquid part of current assets – it is harder to turn them into cash quickly.
read more...»Q&A - How is the current ratio calculated and interpreted?
The current ratio is the classic measure of liquidity. It indicates whether the business can pay debts due within one year out of the current assets. The current ratio reveals how much “cover” the business has for every £1 that is owed by the firm. For example, a ratio of 1.5:1 would mean that a business has £1.50 of current assets for every £1 of current liabilities.
read more...»Q&A - What is the “creditor days” ratio?
“Creditor days” is a similar ratio to debtor days and it gives an insight into whether a business is taking full advantage of trade credit available to it. This ratio estimates the average time it takes a business to settle its debts with trade suppliers.
read more...»Q&A - How can the debtor days ratio be calculated and interpreted?
The debtor days ratio focuses on the time it takes for trade debtors to settle their bills. The ratio indicates whether debtors are being allowed excessive credit. A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. The efficient and timely collection of customer debts is a vital part of cash flow management, so this is a ratio which is very closely watched in many businesses.
read more...»Q&A - Explain the asset turnover ratio
The asset turnover ratio considers the relationship between revenues and the total assets employed in a business. A business invests in assets (e.g. machinery, stocks) in order to make profitable sales, and a good way to think about the asset turnover ratio is imagining the business trying to make those assets work hard (or sweat) to generate sales.
read more...»Q&A - How is stock turnover calculated and interpreted?
Stock turnover helps answer questions such as “have we got too much money tied up in inventory”? An increasing stock turnover figure or one which is much larger than the “average” for an industry may indicate poor inventory management.
read more...»Q&A - What is “profit quality”?
One of the issues to consider when looking at the income statement is to look at whether the reported profit is “high quality” or “low quality”. What is the difference?
read more...»Q&A - What factors determine the amount of working capital in a business?
Many factors affect the level of working capital in a firm. It is important to remember that different industries have different working capital profiles, reflecting their methods of doing business and what they are producing and selling.
read more...»Q&A - What is “working capital”?
By adding together the totals for current assets and current liabilities in the balance sheet, a very important figure can be calculated – working capital. Working capital provides a strong indication of a business’ ability to pay is debts, and is calculated as: current assets less current liabilities
read more...»Q&A - What is depreciation?
Depreciation is a tricky concept to understand and often confuses business students. It is a cost that is recognised in the income statement, but it does not involve a cash flow! How does this happen?
read more...»Q&A - Who are the main users of financial accounts?
The financial accounts provide a wealth of information that is useful to various users of financial information. The key users are described briefly below:
read more...»Q&A - Outline what are meant by financial accounts
Every transaction that a business gets involved with ultimately finds its way into the accounting records and financial statements of the business. In business there are essential two main types of financial reports (or “accounts”):
• Financial accounts – which formally record, summarise and report the transactions of the business
• Management accounts – which present and analyse financial data to help management take decisions and monitor performance
Q&A - What are the main ways a public company can raise finance from shareholders?
Both private and public companies can raise finance by selling new shares in the company. For the purpose of this note, we concentrate on the main options open to a publicly-quoted company – i.e. a company whose shares are quoted and traded on a recognised stock exchange.
read more...»Q&A - Is there an optimal level of gearing?
Gearing varies from firm to firm and from industry to industry. It is important not to rush to judgement about the gearing level of a business without considering other factors such as profitability, liquidity and the competitive position of the business.
read more...»Q&A - What is gearing?
Gearing focuses on the capital structure of the business – that means the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders).
read more...»Q&A - What are the main personal sources of finance an entrepreneur can obtain for a start-up?
In practice, most start-ups make use of the personal financial sources of the entrepreneur. This can be personal savings in the building society, a bank balance. It can be providing assets for the business (e.g. a car). It can also simply be working for nothing! The following notes explain these in a little more detail.
read more...»Q&A - Should a start-up raise investment from outside investors?
You will have seen entrepreneurs making their pitches to the Dragons on Dragon’s Den – this is a good example of how a start-up or small business tries to raise capital by encouraging people other than the entrepreneur to invest in the business idea. But is this a good idea, and who should be asked?
read more...»Q&A - What are the main things to consider when obtaining finance for a start-up?
Often the hardest part of starting a business is raising the money to get going.
read more...»Q&A - Why are start-ups vulnerable to cash flow problems?
Start-ups and small businesses are especially vulnerable to cash flow problems. Here are some of the main reasons:
read more...»Q&A - How can a business handle a loss?
A loss arises when total costs are more than total revenues in a period.
read more...»Q&A - How is profit used by a business?
Profit arises when total sales exceed total cost for a period. Once a profit has been made, the owners of the business have a choice:
read more...»Q&A - What is share capital
Share capital is the money invested in a company by the shareholders. Share capital is a long-term source of finance.
read more...»Q&A - Explain what a bank overdraft is
A bank overdraft is flexible borrowing facility on a bank current account which is repayable on demand.
read more...»Q&A - What taxes will a start-up pay?
The main taxes that a start-up needs to consider are summarised below:
read more...»Q&A - What are retained profits?
Retained profit is the profit kept in the company rather than paid out to shareholders as a dividend. Retained profit is widely regarded as the most important long-term source of finance for a business.
read more...»Q&A - How are businesses affected by changes in interest rates?
The effect of a change in interest rates will depend on several factors, such as:
• The amount that a business has borrowed and on what terms
• The cash balances that a business holds
• Whether the business operates in markets where demand is sensitive to changes in interest rates
Q&A - What is an interest rate?
An interest rate is the cost of borrowing money or the return for investing money.
read more...»Q&A - What is credit and why do businesses need it?
Credit is the lifeblood of any business - it is very difficult for a business to survive, and certainly grow without it. But what is credit?
read more...»Q&A - Why is leasing and hire purchase a source of finance?
Leasing is another word for renting assets (e.g. property) over a period of time. Leasing is a way of financing the use of such assets without actually having to buy them outright.
read more...»Q&A - Why are trade creditors a source of finance?
When a business buys raw materials, components, services or other goods from another business it will often look to pay for those at a later date. If it is allowed to do so, then that supplier is said to offer “trade credit” to the business. The supplier becomes a trade creditor – someone to whom the business owes money.
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