Fixed Assets Ratio Relationships

Ratio Movements Meaning

1.Total fixed A ratio of 0.5 or higher, indicates an
assets/Total assets inefficient use of working capital
which reduces the enterprise's ability
to carry accounts receivable and
maintain inventory and usually Provides evidence whether
means a low cash reserve. fixed assets balances are
An increase in this ratio can also reasonable relative to other
indicate that the firm is over fixed assets balances.
dependent on fixed assets. And it is
likely that they are less liquid.
2.Individual fixed asset Provides evidence whether
account bal./Total fixed fixed assets balances are
assets (TFA) reasonable relative to other
fixed assets balances and
signifies whether that
individual balance is recorded
accurately or not.
3.TFA/ long term debt If FA increases significantly whilst
LT debt doesn’t then it may be an
indication that fraud does exist.
Suspicion of fraud furthers if there is Identifies the relationship
a lack of evidence regarding the use between debt and fixed assets.
of cash, marketable securities to Provides a measure for
purchase fixed assets. solvency
An increase in this ratio can also
indicate that asset is purchased
through short term funds which can
have a negative impact. Possibility
of fraud is present.
4.Depreciation expense It should be fairly stable unless
for various categories changes occurred in depreciation
of assets/ assets being methods, composition or life of This ratio measures how
depreciated assets. Therefore any unreasonable quickly a company is writing
inconsistency of this ratio over a off assets and how diligently
period of time may be an indicator the company is replacing its old
for a fraud. fixed assets with replacements.
A high depreciation to fixed assets It also give clues on how fixed
ratio may suggest that a business is assets are being managed and
writing off old equipment to make whether adequately
way for newer ones or the present depreciated.
fixed assets have a short useful life
and, therefore, need to be replaced
quickly.
5.Accumulated If the ratio increases over time and is Examine whether fixed assets
Depreciation / high relative to its peers, the are being adequately
Depreciable assets company may have trouble depreciated and allows the
generating enough cash to purchase investor to understand if a
new equipment.  If true, the company is generating enough
company's maintenance expense to cash to replace aging
fixed assets ratio should be analysed equipment.
to see if it's declining over time.

Inventory Related Ratios

Calculation Movemen Meanings

t

Gross profit Gross profit divided by sales increase Overstating the inventory balance
(margin) ratio or understating cost of goods
might occur, which might be the
symptom of revenue fraud or
inventory-related fraud.

Inventory Cost of goods sold divided by average decrease It is the symptom of overstating
turnover inventory inventory or understating cost of
goods sold.

Number of Inventory sold dividing the number of increase The average time required for a
Days' sales in days in a period by the inventory company to convert its inventory
inventory turnover ratio ( into sales is longer than before.

Asset turnover sales or revenue divided by total increase The higher the better. It implies
Assets the company is generating more
revenues per dollar of assets

Working Net sales divided by average working decrease The inventory may be overstated
Capital capital (current assets – current especially when inventory
turnover liabilities) comprises a major portion of
current assets.

Operating Net income divided by net sales increase Profit margin increases. Inventory
performance may be overstated or COGS is
ratio understated.

Earnings per (net income-dividends on preferred increase When net income is overstated,
share stock)/average outstanding shares earnings per share increase. When
earnings increase dramatically, the
cause should be investigated, with
the result sometimes being
 overstated inventory or
understated cost of goods sold.

REVENUE RATIO
Ratio Calculation Movement Means
Increase in this ratio might indicate that
company is trying to either:
Gross profit  Overstate net sales
Net sales  Understate sales discounts
 Gross profit =  Understate COGS
Gross profit Net sales – Decrease in this ratio might indicate that
(margin) ratio COGS company is having either:
 Net sales = Total  High COGS
sales – sales  High sales discounts
discount This could imply that they are trying to
improve the quality of product of attract
more customers
It is a signal that too many goods are being
returned.
This might be because of following reasons:
 Company has produced defective
goods;
Sales return Sales return  Late shipment, reaching customers
percentage ratio Total sales when they no longer needed the
product;
 In the case invoiced material did not
the original order;
 In the case customers did not order the
product
 When the ratio becomes unexpectedly low,
it is a signal that fraud or other problems
could be occurring.
Understating sales return is a means to
overstated revenues and income.
Understating sales return can be made
through following ways:
 Company did not record returned
goods from customers;
 Record returned goods after the end of
the period.
If company uses the latter scheme, the
effect would be overstated accounts
receivable.
It might indicate fast payment from
customers (paying within the discount
Sales discount x 100%
Gross sales period term)
Sales discount
Decreasing ratio means customers are
percentage ratio
taking longer time to pay; may indicate a
red flag of not recording discounts in the
accounting records
Increase in the ratio might imply that
company efficiently collects their
receivables during a year since increased
ratio means company have higher capability
Accounts Net credit sales for collecting its average receivables
receivable Average accounts Decrease in the ratio might imply that
turnover receivables company is inefficient in collecting their
receivables throughout one-year period. It
might be a red flag since it refers to
company’s low capability for collecting its
average receivables during the year
Number of days It means that company needs more days to
in receivables 365 collect receivables (longer time in
Accounts receivable collecting receivables). It might indicate red

ratio turnover
N Ratio
1 Allowance for Doubtful
Debts (uncollectable
accounts)as a percentage of
accounts Receivable (AR)
2 Total Asset Turnover
3 Working Capital (WC)
Turnover
4 Operating Performance
Margin
5 Earnings per Share
flags as fictitious receivables often result in
longer time of collection process
It means that company can quickly collect
their receivables as it needs lesser days for
collection process
Formula Explanation
Allowance for DD/Total Understated Allowance for Doubtful
AR Debts leads to AR and Sales being
overstated.
Sales/Total Assets The ratio increases due to increase in
Sales or decrease in total assets (AR in
particular). Both trends may indicate that
revenue-related fraud is occurring.
Sales/Average WC = A significant or sudden increase may be a
Sales /[(CA o/b - CL o/b) symptom of a revenue fraud (i.e.
+ (CA c/b - CL c/b)]*0.5 overstated Sales, Current Assets and AR
in particular or understated Current
Liabilities). Less sensitive to the revenue-
related fraud than 1 and 2 ratios.
Net Income/Total A dramatic increase in this ratio may
Assets suggest that fictitious sales were added
without adding additional expenses.
Net Income /Average This ratio measures the profitability of an
Number of Shares organisation. A dramatic increase in this
Outstanding ratio (i.e. due to the sudden increase in
Net Income) could be a signal that fraud
is occurring (not necessarily a revenue-
related fraud). This is one of the least
sensitive ratios in detecting revenue-
related fraud.