a. Explain accounting ratio giving one example of liquidity ratio
b. State three users of accounting ratios
c. Outline three limitations to the use of accounting ratios
Explanation
a.
Accounting ratios are mathematical calculations used to evaluate and analyze the financial performance and position of a company. These ratios are derived from the financial statements, such as the balance sheet, income statements, and cash flow statement, and provide insights into various aspects of a company's operations, profitability, liquidity, solvency, and efficiency.
Examples of liquidity ratio are: Current ratio, Quick ratio, Cash ratio etc.
b.
- Accounting ratios are used to assess the overall performance of a company by analyzing key indicators such as return on investment, return on assets, and return on equity.
- Accounting ratios such as current ratio, quick ratio, and debt-to-equity help assess the financial health and stability of a business.
- Accounting ratios such as gross profit margin, net profit margin, and return on sales are used to measure a company's profitability
- Accounting ratios like current ratio and quicj ratio help evaluate a company's liquidity position and its ability to meet short-term obligations.
- Accounting ratios play a crucial role in investment analysis by allowing investors use ratios like earnings per share, price to earnings ratio and dividend yield to assess the investment potential of a company's stock.
c.
- Accounting ratios are based on historical financial statements, which may not accurately reflect the current financial position or future prospects of a company.
- Accounting ratios provide numerical indicators but often lack the context behind the numbers.
- Accounting ratios heavily rely on the accuracy and realibility of financial statements. Howevefr, financial statements can be subjective and influenced by management judgments, accounting policies, and potential manipulation
- Accounting ratios primarily focus on financial data, such as balance sheets and income statements, while excluding non-financial aspects like customer satisfaction, employee morale, or brand value.
- Accounting ratios often overlook non-financial factors such as environmental sustainability, social responsibility, or corporate governance practices.