Income statement:
Sales Rs. 500,000
Cost of goods sold 300,000
Operating expenses 60,000
Interest expenses 10,000
Income tax expenses 40,000
Net income 90,000
Balance sheet:
Assets
Cash Rs 10,000
Accounts receivable 15,000
Inventory 20,000
Equipment 455,000
Total: 500,000
Liabilities
Accounts payable Rs 12,000
Long-term notes payable 48,000
Shareholder’s equity:
Capital stock 300,000
Retained earnings 140,000
Total: 500,000
Find and interpret the company’s (i) Current ratio (ii) Quick ratio (iii) Average collection period (iv) Time interest earned (v) Inventory turnover
CSS Solved Business Administration Past Papers | The following data relates to ABC Company… Find and interpret the company’s (i) Current ratio (ii) Quick ratio (iii) Average collection period (iv) Time interest earned (v) Inventory turnover
The following question is attempted by Miss Nimra Masood, the top scorer in CSS Business Administration papers. Moreover, the answer is written on the same pattern, taught by Sir to his students, scoring the highest marks in compulsory subjects for years. This solved past paper question is uploaded to help aspirants understand how to crack a topic or question, how to write relevantly, what coherence is, and how to include and connect ideas, opinions, and suggestions to score the maximum.
Topic Breakdown:
The financial Ratios part is the crux of financial accounting. Be it calculation or its interpretation, students need to be very clear, precise and to the point in order to score maximum marks.
Subject: Financial Management
Chapter: Financial Ratios
1- Current Ratio:
- Formula
- Interpretation
The current ratio is part of the liquidity ratios. It helps to determine the firm’s ability to meet its short-term obligations by using current assets. Therefore, the ratio should ideally be 1 or above it, guaranteeing the firm is liquid enough to pay back its obligation. In this case, a current ratio of 3.75 is exceptionally good, indicating the firm’s strong financial position. However, an analysis of the inventory cycle and bad debts can further elaborate on the condition.
2- Quick Test Ratio:
- Formula
- Interpretation
The quick acid test ratio is also part of the liquidity ratios. It is a test of firm’s ability to pay its short-term obligations with highly liquid assets. This ratio serves as a supplement to the current ratio to give a clear indication of liquidity. It is more penetrating then the current ratio. A quick ratio of 2.0833 is very efficient referring the firm’s ability to payback its short-term obligations with the help of most liquid assets. The time period for which accounts receivable are pending will explain if there is any possibility of bad debts.
3- Average Collection Period:
- Formula
- Interpretation
Receivable turnover gives us an overview as to firm’s quality of receivables. Also, it provides information about the company’s success in collecting its outstanding dues. This ratio is part of the activity ratio, which provides insight into the firm’s efficiency in utilizing its assets. The average collection period tells us about the number of days taken to collect all receivables. This ratio relies heavily on the industry average, which would illustrate trends of other companies in the industry. However, ABC company’s average collection period of 10.95 means it takes around 11 days to recover its accounts receivable.
4- Times Interest Earned:
- Formula
- Interpretation:
This ratio is part of the coverage ratio-which is the financial charges of a firm to its ability to service or cover them. Times interest earned shows the firm’s ability to cover its interest charges. It is also seen as a measure to avoid bankruptcy. The higher the ratio, the better it is. Also, in the case of ABC company, times interest earned ratio of 14 is stable.
5- Inventory Turnover:
- Formula:
- Interpretation:
This ratio is also a part of the activity ratio, which provides insight about the firm’s efficiency to utilize its assets. Inventory turnover ratio determines how effectively the company utilizes its inventory. Higher the inventory turnover ratio, the better it is. It indicates that firm has good liquidity and stock is being updated frequently. ABC company’s inventory turnover of 15 is very attractive, indicating the inventory is replenished 15 times a month.
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