1. Briefly explain the difference between the current ratio and acid test ratio (5marks) Current ratio is a measure of the ability of a business to meet short-term debts. The formula for this is current assets/current liabilities. The results from the formula will show for every £1 of current liabilities the business will have £X amount of current assets. The typical ‘ideal’ figure for the current ratio is 1.5-2:1 meaning £1.50-£2.00 of current assets to £1 of current liabilities. The acid test is ratio is a measure of the ability of a business to meet short-term debts from liquid assets. The formula for this is current assets-inventories/ current liabilities. The result from the formula will show for every £1 in current liabilities the business will have £X amount of current assets, the ideal figure to reach is 0.75-1:1.The difference between the two is that the acid test does not take into account inventories because they can take time to sell inventories and turn into cash.
2. Why would the acid test ratio be of greater significance to a retailer of ladies’ fashion than a provider of health and safety training? (4marks) The acid test would be more beneficial to a women’s fashion retailer because it takes away the inventories which will have a higher figure due to its stock therefore it will show the financial efficiency of its business whereas a health and safety business acid test ratio will be similar to its current ratio test because it won’t have much inventories to take away.
3. What is meant by ROCE? (3marks)
Return on capital employed is a measure of how efficiently a business is using its capital to generate profits. The formula is operating profit/ (total equity+ non-current liabilities) X 100. This calculation with give a percentage showing the percent the business is making per the capital invested.
4. Explain why a business might want receivables (debtor) days to be shorter than creditor days...