Analysis and Interpretation Financial Stability YEAR 11 ACCOUNTING Analysis and Interpretation Financial Stability

CLASSIFICATION OF RATIOS/PERCENTAGES We are looking at this today!!!

How to evaluate businesses’ results? Please follow the steps as follows: Calculate Percentages/Ratios Explain the meaning of the Percentage/Ratios Unsatisfactory Trend Look at the financial statements and formula and identify what has been changed? Identify the trend Satisfactory Trend Look at the financial statements and formula and identify what has been changed? Why was there a change in the financial statements? Provide a recommendation/s to overcome the unsatisfactory trend. Why is there a change in the financial statements?

Financial Stability Financial Stability means: The level of stability a business has on continuing its operation into the foreseeable future in terms of the weighting between equity and liability.

Measures of Financial Stability The following analysis is classified under financial stability: Equity Ratio

EQUITY RATIO BENCHMARK 0.6:1 Meaning: It means for every $1 of total assets, XX cents is FINANCED by the owner. The result shows the business IS/IS NOT facing pressure of repaying debt and has GREATER/LESS chance of accessing external funds.

Example If the equity ratio shows 0.70:1. This means for every $1 of total assets, 70 cents is FINANCED by the owner. This result shows that the business is NOT facing pressure of repaying debts and are ABLE to access further external funds.

Equity Ratio in a Pie Chart The business is NOT facing pressure of repaying debts and the business is NOT facing a risk of to be controlled by external parties, such as bank.

Calculation 2005 2006 ASSETS Current Assets 4,000 3,000 Non Current Assets (PPE) 30,000 34,000 40,000 43,000 LIABILITIES Current Liabilities 3,800 5,000 Non Current Liabilities 10,000 13,800 15,000 20,000 NET ASSETS 20,200 23,000

Calculation 2005 2006 EQUITY Capital – 1 April 40,000 20,200 Plus: Net Profit 10,000 25,000 50,000 45,000 Less: Drawings 29,800 22,000 Capital – 31 March 23,000

Calculation 2005 2006 Equity Ratio

Satisfactory/Unsatisfactory Ratio The Equity Ratio in 2006 showed a SATISFACTORY or UNSATISFACTORY result. The next step is to describe the reason, using the Balance Sheet.

Identify the Trend The Equity Ratio showed a SATISFACTORY or UNSATISFACTORY trend.

Reason (surface level) Despite Equity showing an increasing trend, the growth rate of liabilities is faster than the growth rate of equity, which means more assets are financed by outsiders. Liabilities Equity Ratio Equity

Reason (deep level) The reason that a higher growth rate of liabilities occurred: The business purchased more property, plant and equipment by borrowing a long term loan instead of an owner’s contribution. (Look at the Balance Sheet)

Other situations that causes an equity ratio to show an unsatisfactory result When the owner withdraws excess cash or goods from the business (More drawings, Less Cash) When the business has bought its assets ALL on credit. When the business has made a loss during a financial year.

Recommendations Cause Recommendation When the owner withdraws excess cash or goods from the business (More Drawings, Less Cash) Reduce the level of drawings, this will keep more owner’s funds in the business. When the business has bought its assets ALL on credit. If sufficient cash is available, try to finance the asset purchase by using some of the business’s cash. When the business has made a loss during a financial year. Check the expenses, review the mark-up policy etc.