Financial ratios are used to analyse how the business is faring (to know the companies health

and its potential to grow). Financial ratios is simply the comparison between detailed
information derived from the organizations financial statements. These ratios can be used to
observe the current performance of the company comparing to the previous period this can
further help the company identify the problems it’s facing and how to fix them. The ratios
can as well used as a benchmark of performance against the performance of the company’s.
Some examples of financial ratios include liquidity efficiency, common size rations and
solvency ratios.

COMMON SIZE RATIOS 

Common ratios is one of the ways a business can get to look its financial statements, they can
be derived from the balance sheet and income statements. Common size ratio is calculated
by computing all the asset category from the balance sheet as a proportion of the overall
assets and all the liabilities as a proportion of overall liabilities plus the owner’s equity from
the balance sheet

LIQUIDITY RATIOS 

Liquidity ratios measures the business capability to shield its expenditures, examples of the
liquidity ratios are current ratio and quick ratio.

Current Ratio: it measures the financial strength of the company. It measures the number of
times an organisation current assets surpasses the current liabilities giving an indication of
how solvent the company is. The current ratio can be expressed using the formula below.

Current Ratio = Total current assets/Total current liabilities

The current ratio that is between 2-1 is good (acceptable).

Quick Ratio

At times called the acid test ratio, the quick ratio measures the company’s most liquid assets
and relates them to the liabilities of the company. Examples of assets that are most liquid
assets and liabilities include cash, bonds, account receivables and stocks. The following is the
formula of the quick ratio.

Quick Ratio = (Current Assets − Inventory)/Current Liabilities

The ratios ranging between 0.5 and 1 reflects to be adequate.

Net Working Capital Ratio

It is a measure of cash flow. The answer to this ratio should be positive. Usually, the bankers
keep an eye on this ratio to see whether there is a financial crisis or not. Thus,

Net Working Capital Ratio = Current Assets – Current Liabilities

OPERATING RATIOS 

The efficiency of the business operations is measured using the operating ratios. There are
four types of operating ratios namely, return on assets, inventory, day’s receivables and sales
to receivables

Inventory Turnover: it is used to measure the number of time an inventory is changed into
sales in a particular time frame. The inventory turnover is calculated using the formula below

Inventory Ratio = Cost of Goods Sold/Inventory

The higher the ratio the faster the inventory is transformed into sales.

Sales-to-Receivables Ratio: this ratio is used to calculate the number of times account
receivables get converted in a particular period of time.

Sales-to-Receivables Ratio = Net Sales/Net Receivables

The greater the sales receivables the smaller the period for making sales and collecting cash.

Days' Receivables Ratio: this measures how long the account receivables are unpaid.

It is computed using the formula:

Days' Receivables Ratio = 365/Sales Receivables Ratio

Return on Assets: the ROA processes the link between the profits an organisation made and
the assets that were used to make the profits

It is calculated using the formula below:

Return on Assets = Net Income before Taxes/Total Assets X 100

CALCULATIONS
FOR THE YEAR 2014
Current Ratio = Total current assets/Total current liabilities

Current Ratio = 650/-513= -1.27

The ratio is not adequate, the company does not have enough to pay for its short term
obligations.

Quick Ratio = (Current Assets − Inventory)/Current Liabilities

Quick Ratio = (650 − 0)/-513= -1.27

The ratio is not adequate, the company does not have enough to pay for its short term
obligations.

Net Working Capital Ratio = Current Assets – Current Liabilities

Net Working Capital Ratio = 650 – (-513) = 1163

The working capital is adequate for the company

Return on Assets = Net Income before Taxes/Total Assets X 100

Return on Assets = 98/765 X 100= 13%

Each kwacha of assets held by this company is generating K0.13 on average.

Debt ratio = debt /total assets

Debt ratio = 325 /765= 42%
In general, having a lower debt-asset ratio is preferred by creditors because more equity
funds are available to meet the company’s financial obligations. The debt ratio for 2014
is 0.42. This means that 42% of the company’s assets are financed by debt

FOR THE YEAR 2019

Current Ratio = Total current assets/Total current liabilities

Current Ratio = 1000/-982= -1.02

The ratio is not adequate, the company does not have enough to pay for its short term
obligations.

Quick Ratio = (Current Assets − Inventory)/Current Liabilities

Quick Ratio = (1000-0)/-982= -1.02

The ratio is not adequate, the company does not have enough to pay for its short term
obligations.

Net Working Capital Ratio = Current Assets – Current Liabilities

Net Working Capital Ratio = 1000– (-982) = 1982

The working capital is adequate for the company

Return on Assets = Net Income before Taxes/Total Assets X 100

Return on Assets = 150/1410 X 100= 11%

Each kwacha of assets held by this company is generating K0.11 on average.

Debt ratio = debt /total assets

Debt ratio = 500 /1410= 35 %
In general, having a lower debt-asset ratio is preferred by creditors because more equity
funds are available to meet the company’s financial obligations. The debt ratio for 2019
is 0.35. This means that 35% of the company’s assets are financed by debt

ii) Sources of finance for business are equity, debt, debentures, retained earnings, term loans,
working capital loans, letter of credit, euro issue, venture funding etc. These sources of funds
are used in different situations. They are classified based on time period, ownership and
control, and their source of generation.

Having known that there are many alternatives to finance or capital, a company can choose
from. Choosing the right source and the right mix of finance is a key challenge for every
finance manager. The process of selecting the right source of finance involves in-depth
analysis of each and every source of fund. For analysing and comparing the sources, it needs
the understanding of all the characteristics of the financing sources. There are many
characteristics on the basis of which sources of finance are classified.

On the basis of a time period, sources are classified as long-term, medium term, and short
term. Ownership and control classify sources of finance into owned and borrowed capital.
Internal sources and external sources are the two sources of generation of capital.

A firm needs funds to purchase fixed assets such as land, plant and machinery, furniture, etc.
These assets should be purchased from those funds which have a longer maturity repayment
period. The capital required for purchasing these assets is known as fixed capital. So funds
required for fixed capital must be financed using long-term sources of finance.

Funds required for meeting day-to-day expenses, i.e. revenue expenditure or working capital
should be financed from short-term sources whose maturity period is one year or less

Owned capital is also a major source of finance, it represents equity capital, retained earnings
and preference capital. Equity share has a perpetual life and are entitled to the residual
income of the firm but the equity shareholders have the right to control the affairs of the
business because they enjoy the voting rights. Funds can also be accessed through borrowed
capital which represents debentures, term loans, public deposits, borrowings from bank, etc.
These are contractual in nature. They are entitled to get a fixed rate of interest irrespective of
profit and are to be repaid on a fixed date