Preparing Final Accounts (Accounting Ratios)

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Preparing Final Accounts Outcome 4 Assignment 1. Explain what is meant by “ratio” A ratio is a mathematical tool that can be used to compare the relationship between two or more sets of numbers. A basic example of this would be the ratio of boys to girls in a class room. E.g. there are 10 boys and 20 girls in class, the ratio of boys to girls is 10:20, or 1:2 in simplified form. Ratios can also be expressed as a decimal number (0.5), as a fraction (1/2), or as a percentage (50%). 2. Explain what is meant by “accounting ratios” An accounting ratio takes numerical data from financial statements, such as a profit and loss account or balance sheet, and compares them to reveal relationships between the data. 3. Explain what is meant by “ratio analysis” Ratio analysis in the interpretation of the resulting data given by the accounting ratio(s). Examples are given in next section of this assignment. 4. Discuss the advantages and the limitations of “ratio analysis” There are several advantages and limitations of accounting ratios, I will address some of the key ones in this section Advantages * Accounting ratios can be used by investors to make decisions on whether or not to invest in a company or sell existing shares. * Accounting ratios can be used by management to give an indication of a company’s financial health i.e. is the company profitable? Can they meet creditor obligations? Are stock levels being efficiently managed? * Accounting ratios reveal strengths and weaknesses within a company. * Accounting ratios allow management to run an efficient and profitable business. Disadvantages * Accounting ratios only account for numerical factors, factors such as, good or bad customer service, quality of product or services provided, marketing strategy etc. are not taken in to consideration. *

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