Accounting Business Reporting for Decision Making

CHAPTER 8 Analysis and interpretation of financial statements 363

Ratio Calculation

iv.Interest coverage ratio

=

Earnings before interest and tax

Net finance costs

=

30 032

4 000

= 7.51 times

v.Profit margin

=

Profit (loss)

× 100

Sales revenue

=

18 822

× 100

115 750

= 16.26%

vi.Asset turnover ratio

=

Sales revenue

Average total assets

=

115 750

(161 985 + 148 168)/2

= 0.75 times

vii.Days debtors

=

Average accounts receivable

× 365 days

Sales revenue

=

(21 750 + 23 675)/2

× 365 days

115 750

= 71.62 days

Comprehension questions

8.4 Users are interested in an entity’s future profitability, asset efficiency, liquidity and

capital structure. Describe the ratios that would be of interest to users and the

purpose of computing these ratios. LO4, 5, 7

8.5 Your friend has $5000 to invest in the stockmarket and is deciding between an investment

in Ability Ltd or Absolute Ltd. In the most recent reporting period, Absolute Ltd made

a profit after tax of $1 000 000, compared to Ability Ltd’s after-tax profit of $500 000.

On this basis, your friend believes Absolute Ltd is the superior investment. Discuss your

friend’s investment choice. In doing so, suggest other financial data that should be

considered. Identify the non-financial data that may be of interest to inform your friend’s

investment decision. LO2, 4

8.6 When calculating the return on asset ratio, the average asset balance is used as the

denominator. When calculating the debt ratio, the year-end asset balance is used as the

denominator. Explain the rationale for using average asset figures for some ratios and

year-end asset figures for others. LO3

8.7 Identify what ratios a bank lender would be particularly interested in. LO1

8.8 The working capital ratio for Beesnees Business has progressively increased from

1.2 times to 3.0 over the past three years. Discuss if this trend is favourable. LO6

8.9 Earnings before interest and tax (EBIT), rather than profit, is sometimes used as the numerator

in the return on asset ratio. Discuss the rationale for using EBIT rather than profit. LO4