Financial Management/Management Accounting

The Acid Test Ratio (or Quick Ratio) is calculated as (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities. It is not the ratio of equity to fixed interest-bearing securities, which is related to capital gearing.

The Debt-Equity Ratio measures the proportion of debt to equity in a company's capital structure. It is a fundamental solvency ratio used to assess a firm's long-term financial stability.

Ratio analysis is primarily a tool for financial analysis and interpretation of past performance. While it informs planning, it is not a technique of planning and control itself; budgeting and standard costing are.

The rate of return on capital employed (ROCE) is a profitability ratio, not a turnover ratio. Turnover ratios measure how efficiently a company uses its assets (e.g., inventory turnover).

Solvency refers to the ability of a company to meet its long-term financial obligations, including interest payments and the repayment of principal on long-term debt.

Capital gearing is the ratio of fixed-interest-bearing capital (debt and preference shares) to equity capital. It is not simply the ratio of debt to equity.

Low gearing is generally considered safer because it indicates that a company has less debt relative to equity, reducing the risk of financial distress during economic downturns.

The Acid Test Ratio is a liquidity ratio that measures a company's ability to pay off its short-term liabilities with its most liquid assets (excluding inventory).

The Stock Turnover Ratio is calculated as Cost of Goods Sold divided by Average Stock. Using the average stock provides a more accurate representation than using only the closing stock.

A decreased Stock Turnover Ratio typically indicates that inventory is moving more slowly, which often suggests poor sales or overstocking rather than an expanding business.

Purchase of stock-in-trade is a current asset transaction, not an application of funds. Application of funds refers to the use of long-term financial resources for non-current purposes.

Funds flow refers to the movement of working capital, which involves changes in current assets and current liabilities. It is not limited to long-term funds.

The funds flow statement summarizes the net changes in working capital as a whole. It does not list the individual changes in every current asset or liability account.

A funds flow statement covers a period of time, showing the movement of funds between two balance sheet dates. It is not a snapshot of the position on a single closing date.

Working capital is defined as current assets minus current liabilities. If current liabilities decrease, the total working capital increases.

Working capital is current assets minus current liabilities. When cash or credit sales occur at a profit, current assets either increase through cash or accounts receivable by an amount greater than or equal to cost, thereby increasing net working capital.

A cash flow statement specifically tracks the inflows and outflows of cash and cash equivalents over a period.

Amortization is a non-cash expense. It does not involve an actual outflow of funds, so it is not considered a use of funds in a funds flow statement.

Payment of a dividend requires an outflow of cash, which reduces the total funds available to the business.

Purchasing a fixed asset involves an outflow of cash or the creation of a liability, which is an application (use) of funds.

In cash flow analysis, 'funds' refers specifically to cash and cash equivalents, not current assets in general.

Working capital is defined as current assets minus current liabilities, not fixed assets minus current assets.

An income statement shows profitability (revenue vs. expenses), while a cash flow statement shows liquidity (cash inflows vs. outflows). They serve different purposes.

Holding excessive cash is inefficient as it does not earn a return and represents idle capital that could be invested elsewhere.