2.

Intended Learning Outcomes (ILOs)

2.1 Liquidity ratios

The first of our ratio analysis is the Liquidity test.

Under the Liquidity test, the management accountant will analyze if the entity is able to pay its short-term obligations as it becomes due.

We will be using the illustrative statement of financial position and income statement of One Sweet Day Corporation.

But in this ratio analysis, we are only focusing on current assets, current liabilities, and temporary accounts.

For your own practice, we leave the solution blank. Try to answer it in a separate sheet

Do not worry the answers are shown in the interpretation. If you have questions you can chat me or we can use canvas discussion.

So let's get started!

For the liquidity tests, we have three namely: working capital, current ratio, and quick acid ratio.

With these regards, One Sweet Day Corporation is liquid because it passes all three liquidity test ratio analysis.

However, if the entity passed in the 1st two ratios but failed the quick asset ratio, the entity is said to be not liquid.

Because the most liquid assets of the entity (or the quick assets) is not enough to pay its current liabilities as it becomes due.
To further analyze the operation of One Sweet Day Corporation, we perform operating efficiency ratios on the next module.

2.2 Operating efficiency ratios

To identify improvements within the entity's operation, the management accountant performs operating efficiency ratios such as Accounts receivable
turnover, average collection period, inventory turnover, and average sales period.                                                            

We use again the data of One Sweet Day Corporation:

Prepare your separate practice note and let's get started!

Analyzing it, we determine that One Sweet Day should compare the result of its operating efficiency ratios with the industry
average.                                                                     

It seems that the 43.50 collection period is beyond the normal 30 day period that we know.  

While the 92.64 days to sell inventory is also beyond the normal 30 day period that we know.                                                                

But, again, we need to know the industry average first, what should be the norm in that industry.                                                                        

If it is beyond normal, then, we need to take corrective actions on certain areas such as:                                                                 

1. We can tighten credit policy to improve collection.                                                             

2. We can also allocate more budget on marketing to improve the sale of our product.     

2.3 Solvency ratios

Solvency means the ability of the company to meets its obligations.                                                

Notice this time, it is not only short-term but also long-term which normally covers the major part of the company's liability.                                        

Long term creditors are concern with the ability of the company to pay its obligation in the long run.                                                    

Under Solvency, we will be computing the times' interest earned ratio, debt to equity ratio, and debt ratio.                                                            

 A ratio of less than 1.0 is inadequate.                                                          

We again use the illustrative statement of financial position and income statement of One Sweet Day Corporation.    
Have you filled in the One Sweet Day data is your separate note?

After performing such ratio analysis, we interpret that One Sweet Day Corporation is solvent because its times' interest earned ratio is greater than
1. 

2.4 Ratios useful for Ordinary shareholders

As a management accountant, we also need to learn the ratios useful for ordinary shareholders.                                                           

These ratios focus on net income, dividends, and stockholders’ equities.                                                            

We have four namely: earnings per share (EPS), price-earnings per share, dividends payout ratio, and dividend yield
ratio.                                                   

We will again be using the data of One Sweet Day Corporation:     

 
We compute the ratio one by one:

2.5 Return on asset and equity

Our last two ratios measure how well the company utilizes assets or equity to earn a profit.         

So get again your practice note and we solve the ratios using One Sweet Day Corporation data:
As a future management accountant, you can also compare it with the industry average. Benchmark, the ratio analysis results of One Sweet Day
Corporation within the industry it belongs (e.g.  retailers) and analyze how well One Sweet Day Corporation is utilizing its resources to earn a profit.

2.6 Summary

1. Liquidity ratios measure the entity’s ability to pay its short-term obligations as it becomes due. 

2. Operating efficiency ratios measure the operation of the company to identify certain improvements in collection and sales conversion.

3. Solvency measure the ability of the company to meets its obligations and focus on long-term creditors.

4. As a management accountant, we also need to learn the ratios useful for ordinary shareholders. These ratios focus on net income,
dividends, and stockholders’ equities.         

5. ROA and ROE measure how well the company utilizes assets or equity to earn the profit.