hi guys
check some of following terms u should be aware of, if from commerce back ground
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HOW TO CALCULATE ACID-TEST RATIOWHAT IT MEASURES How quickly a companys assets can be turned into cash, which is why assessment of a companys liquidity also is known as the quick ratio, or simply the acid ratio.
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READING A BALANCE SHEET A balance sheet will tell us something about the financial strength of a business on the day that it is drawn up. That situation changes constantly, so you could say it is more like a snapshot than a movie. Although the method of producing a balance sheet is standardised, there can be a certain element of subjectivity in interpreting it. Different elements of the balance sheet can tell you different things about the how the business is doing.
This actionlist gives an overview of a balance sheet and looks at a brief selection of the more interesting figures that help with interpretation. Its important to remember that a lot of these figures do not tell you that much in isolation, it is in trend analysis or comparisons between businesses that they talk more lucidly.
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What does a balance sheet not do?A balance sheet is not designed to represent market value of the business. For example, property in the balance sheet may be worth a lot more than its book value. Plant and machinery is shown at cost less depreciation, but that may well be different from market value. Stock may turn out to be worth less than its balance-sheet value, and so on.
Also there may be hidden assets, such as goodwill or valuable brands, that do not appear on the balance sheet at all. These would all enhance the value of the business in a sale situation, yet are invisible on a normal balance sheet.
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Defining the individual elements of balance sheet- Fixed assetsitems that are not traded as part of a companys normal activities but enable it to function, such as property, machinery or vehicles. These are tangible assets (meaning you can kick them). This heading can also include intangible assets (you cannot kick them). A common example is goodwill, which can arise upon the acquisition of one business by another.
- Current assetsitems that form the trading cycle of the business. The most common examples are stock, debtors, and positive bank balances.
- Current liabilitiesalso items that form the trading cycle of the business but represent short-term amounts owed to others. Examples will be trade creditors, taxes, and bank overdraftsbroadly, any amount due for payment within the next 12 months from the date of the balance sheet.
- Net current assetsnot a new figure, but simply the difference between current assets and current liabilities, often shown because it may be a useful piece of information.
- Long-term loansdebt that is repayable more than one year from the date of the balance sheet.
- Net assetsalso not a new figure, but the sum of fixed assets plus net current assets less long-term loans. In other words, all of the company assets shown in its books, minus all of its liabilities.
- Profit and loss accountthe total of all the accumulated profits and losses from all the accounting periods since the business started. It increases or decreases each year by the net profit or loss in that period, calculated after providing for all costs including tax and dividends to shareholders.
- Share capitalthe number of shares issued, multiplied by their nominal value. The latter is the theoretical figure at which the shares were originally issued and has nothing to do with their market value.
- Shareholders fundsnot a new figure, but the sum of the profit and loss account plus the share capital. It represents the total interest of the shareholders in the company.
How to interpret themNote that balance sheets differ between one industry and another in the sense of the range and type of assets and liabilities that exist. For example, a retailer will have little in the way of trade debtors because it sells for cash, or a manufacturer is likely to have a far larger investment in plant than a service business like an advertising agency. So the interpretation must be seen in the light of the actual trade of the business.
Reading a balance sheet can be quite subjectiveaccountancy is an art, not a science and, although the method of producing a balance sheet is standardised, there may be some items in it that are subjective rather than factual. The way people interpret some of the figures will also vary, depending what they wish to achieve and how they see certain things as being good or bad.
Look first at the net assets/shareholders fundsPositive or negative? Our example, being a healthy business, has net assets of a positive 1,100. Positive is good. If there were 600 shares in issue, it would mean that the net assets per share are 1.83.
If it had negative assets (same thing as net liabilities), this might mean that the business is heading for difficulty unless it is being supported by some party such as a parent company, bank, or other investor. When reading a balance sheet with negative assets, consider where the support will be coming from.
Then examine net current assetsPositive or negative? Again, our example has net current assets of a positive 300. This means that, theoretically, it should not have any trouble settling short-term liabilities because it has more than enough current assets to do so. Negative net current assets suggest that there possibly could be a problem in settling short-term liabilities.
You can also look at NCA as a ratio of current assets/current liabilities. Here, a figure over one is equivalent to the NCA having a positive absolute figure. The ratio version is more useful in analysing trends of balance sheets over successive periods or comparing two businesses.
A cut-down version of looking at NCA considers only (debtors + cash)/(creditors) thus excluding stock. The reasoning here is that this looks at the most liquid of the net current asset constituents and again a figure over one is the most desirable. Also a ratio that is more meaningful in trends or comparisons.
The significance of trade debtor payments Within current assets, we have trade debtors. It can be useful to consider how many days worth of sales are tied up in debtorsgiven by (debtors 365)/annual sales. This provides an idea of how long the company is waiting to get paid. Too long, and it might be something requiring investigation. However, this figure can be misleading, where sales do not take place evenly throughout the year. A construction company might be an example of such a business: one big debtor incurred near the year end would skew the ratio.
and trade creditor paymentsSimilar to the above, this looks at (trade creditors 365)/annual purchases, indicating how long the company is taking in general to pay its suppliers. This is not so easy to calculate because the purchases for this purpose include not only goods for resale but all the overheads as well.
DebtImportant to most businesses, this figure is the total of long and short-term loans. Too much debt might indicate that the company would have trouble, in a downturn, in paying the interest. It is difficult to give an optimum level of debt because there are so many different situations, depending on a huge range of circumstances.
Often, instead of an absolute figure, debt is expressed as a percentage of shareholders funds and known as gearing or leverage. In a public company, gearing of 100% might be considered pretty high, whereas debt of under 30% may be seen as on the low side.
