Liquidity Ratios are used to measure the company’s pay its short-term or maturing obligations

and to meet unexpected needs for cash. These ratios are:

a. The Current Ratio – This ratio is used to evaluate a company’s ability to pay debts

in the short-term using all of its current assets. It is computed by dividing the total

sum of Cash, Short-Term Investments and Net Receivables by Current Liabilities

as illustrated below.

Current Assets
Current Ratio=
Current Liabilities

b. The Acid-Test Ratio – This ratio is used to evaluate a company’s immediate

liquidity. In other words, it is the company’s ability to pay current liabilities, if

they were to become due immediately, using the most liquid assets (i.e. Cash,

Short-term investments and Net Receivables. It is computed by dividing these

Monetary Current Assets by Current Liabilities as illustrated below.

Cash+Short−Term Investments + Net Receivables

Acid−Test Ratio=
Current Liabilities

c. Accounts Receivable turnover – This ratio measures how effectively a company’s

extends credit and collects debts. Simply stated, it determines the average number

of times a company collects receivables during the period. It is computed by

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 dividing net credit sales by the average net accounts receivable as illustrated

below:

Net Credit Sales

Accounts Receivable Turnover=
Average Net Accounts Receivable

d. Inventory Turnover – This ratio is used to measure the liquidity of the inventory

by averaging the number of times the inventory is sold during the period. It is

computed by dividing the Cost of Goods Sold by the average inventory as

illustrated below:

Cost of Goods Sold

Inventory Turnover=
Average Inventory

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2) Horizontal analysis, which is also known as trend analysis, evaluates a series of financial

statement data over a period of time to determine increases/decreases over a set period of

time, usually two years of more (e.g. 2017 to 2019.) Each line item is compared to the

previous year(s) and the difference is noted in both amount and percentage using the

following formulas:

Current Year Amount−Base Year Amount

Change Since Base Period=
Base Year Amount

Current Year Amount

Current Results∈Relation ¿ Base Period=
Base Year Amount

This is applied to:

a. Statement of financial position,

b. Income statement, and

c. Retained earnings statement.

It is significant as it allows interested parties to analyze the company's financial

performance over a set number of years while aiding to identify trends and growth

patterns.

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3) Management Accounting is used by internal stakeholders such as departmental managers,

directors and company officers, to guide decision making processes, planning and the

general running of the company. It generates detailed internal reports which are useful to

Management as it involves budgeting, cost accounting, making financial comparisons of

operating alternatives, income projections, forecasting, and tax planning and preparation

to name a few.

Financial accounting on the other hand generates information needed by external

stakeholders and is geared towards making decisions in investments and lending. It

generates general purpose financial statements which provided a general overview of the

company’s position.

The major differences between Management Accounting and Financial Accounting is

outlined in the table below:

 Necessity: Financial Accounting is mandatory, requires that the information be

accurate in order to meeting the standards set out by governing authorities while

Management Accounting is completely optional.

 Purpose: Management Accounting is used to guide decision making, planning and

day-to-day operations. Financial Accounting, on the other hand, produces financial

statements for by external parties.

 Users: Management Accounting is used for report to mainly internal parties while

Financial Accounting reports information needed by external parties.

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 Structure: Financial Accounting uses the basic equation of Assets = Liabilities -

Owners’ equity while in Management Accounting there are no set structures.

 Time orientation: Management Accounting uses both historical data and futuristic

estimates to accomplish its purpose while Financial Accounting works only with

historical data.

 Information content: Management Accounting uses both monetary and non-monetary

(market trends, cultural impact, etc.) information to guide preparation of reports while

Financial Accounting primarily uses monetary information.

 Precision: Financial Accounting requires precision thus there are fewer

approximations than in Management Accounting which, due to its use of futuristic

projections, has more approximations.

 Reporting frequency – In Financial Accounting reports are usually generated

Quarterly and annually while in Management Accounting reports are generated

according to the purpose of the report thus frequency can be as often as weekly, and

monthly are common

 Timeliness: Reports issued in a prompt manner in Management Accounting as the

information is needed to guide decision, etc. and can affect day to day running while

in Financial Accounting reports are generated to the end of the period and is often

delayed by weeks or even months.

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4) Cost Accounting is one of the tools of Management Accounting. How can it be useful to

Management?

Cost accounting refers to the application of accounting and costing principles, methods,

and techniques in ascertaining of costs and the analysis of savings or excess cost incurred

in comparison to previous experience or with standards. It measures the resources used in

performing activities, particularly in the production of goods or the delivery of services.

The cost of producing goods or delivering services is the total sum of the costs directly

associated with the goods or services(direct costs) plus a portion of costs incurred in

producing these and other goods or services (indirect costs). It also measures the costs

(direct and indirect) of any other activities management is interested in.

Management uses this information in financial reporting, analyses of profitability,

answering the question “What did it cost?”, arriving at prices in regulated industries and

normal pricing.

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5) What are the benefits of Budgeting?

Budgeting is the planning of the overall activities of the company for a specific period,

usually a year. Its main objective is the coordination of plans made for various aspects of

the organization to ensure that they harmonize. It also helps managers determine if the

coming year’s activities is likely to produce satisfactory results and, where it isn’t, decide

what should be done. Some benefits include:

 Planning orientation - The process of creating a budget forces management to think

of the long-term goals.

 Profitability review - A budget highlights what aspects of the company produces

money and which uses it thus forcing management to consider areas for improving

profitability.

 Funding planning - A budget would identify the amount of cash that will be needed

to support operations and can be used for investment planning.

 Cash allocation – A budget aids in determining what areas and or assets is most

worthy for investment.

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 6) The subsequent ratios was prepared for the Willingham Company Limited using the

following comparative Statements of Financial Position:

Willingham Company Limited

Statements of Financial Position

2019 2018
Fixed Assets 205,000 190,000
Inventory 50,000 50,000
Accounts Receivable 90,000 50,000
Short Term 20,000
Investments
Cash 10,000 30,000
375,000 320,000

Share Capital 140,000 120,000

Retained Earnings 65,000 40,000
Long Term Loan 120,000 100,000
Accounts Payable 50,000 60,000
375,000 320,000

Also, the following additional information was relevant:

1) Net Income was $ 30,000

2) Credit Sales were $ 420,000.

3) Cost of Goods Sold was $ 190,000

a) Current Ratio

Current Assets = Inventory, Accounts Receivable, Short Term Investments, Cash

Current Liabilities = Accounts Payable

Year 2019 2018

50,000+ 90,000+20,000+10,000 50,000+ 50,000+30,000
50,000 ¿ 60,000
¿
170,000 130,000
50,000 60,000

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 Ratios 3.4:1 2.17:1
:
b) Acid Test Ratio

Monetary Current Assets = Accounts Receivable, Short Term Investments, Cash

Current Liabilities = Accounts Payable

Year 2019 2018

$ 90,000+ $ 20,000+ $ 10,000 $ 50,000+ $ 30,000
$ 50,000 ¿ $ 60,000
¿
$ 120,000 $ 80,000
$ 50,000 $ 60,000

Ratios: 2.4:1 1.33:1

c) Accounts Receivable Turnover

$ 420,000 $ 420,000 $ 420,000

= = = 6 times
(($ 90,000+$ 50,000)/2) $ 140,000 /2 $ 70,000

d) Inventory Turnover

Cost of Goods Sold $ 190,000 $ 190,000 $ 190,000

= = = = 3.8 times
Average Inventory (($ 50,000+ $ 50,000)/2) $ 100,000 /2 $ 50,000

e) Gross Profit Margin

Net Income $ 30,000

= = 7.14%
Net Sales $ 420,000