# BAFS Elective Part Accounting Module - Financial Accounting

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1 Accounting Module - Financial Accounting : Technology Education Section Curriculum Development Institute Education Bureau, HKSARG April 2009

2 Accounting Ratios Profitability Ratios Liquidity Ratios Management Efficiency Ratio 2

3 Profitability Ratios Gross Profit Ratio Net Profit Ratio Gross Profit Sales X 100% Net Profit Sales X 100% 3

4 Liquidity Ratios Current Ratio Liquid Ratio (Quick Ratio / Acid Test Ratio) Current Assets Current Liabilities X 100% Current Assets - Inventory Current Liabilities X 100% 4

5 Management Efficiency Ratios Credit Period Allowed to Debtors Credit Period Received from Creditors Stock Turnover Rate Average Accounts Receivable Sales X 365 days Average Accounts Payable Purchases X 365 days Return on Capital Employed Cost of goods sold Average Stock Profit before interest and tax Owners equity + preference shares + long term liabilities X 100% 5

6 Activity 1: Matching (Refer to Student Worksheet P.1) 6

7 Activity 1: Matching ANSWER Match the following ratios with the correct formulas: Current Asset Gross Profit Ratio Net Profit Ratio Current Ratio Liquid Ratio Stock Turnover Rate Debtors collection period Creditors repayment period Return on capital employed 7 Current Liabilities Profit before interest & tax Equity, Preference shares & LT Liabilities Net Profit X 100% Sales Average Accounts Receivable Sales Gross Profit Sales X 100% Cost of goods sold Average Stock Current Assets - Inventory Current Liabilities X 100% Purchase X 365 days Average Accounts Payable X 365 days

8 Activity 2: Problem Solving Refer to Student Worksheet P.2-3 Calculation of the accounting ratios 8

9 Activity 2: Suggested ANSWER Calculate the following ratios of two companies: Profitability Ratios North Ltd South Ltd Gross Profit Ratio 65% 57.4% Net Profit Ratio 8.6% 14.6% Liquidity Current Ratio 6.0:1 2.7:1 Quick Ratio 4.8:1 2.2:1 Management Efficiency Stock Turnover Rate 4.0 times 4.5 times Credit Period Allowed to Debtors 113 days 73 days Credit Period Received from Creditors 79 days 169 days 9 Topic Return A04 on Capital Employed 10% BAFS 6.7% Elective Part

10 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios of the company and its competitor, PlayGame Company Limited. Based on her workings, please advise your boss which one is better by putting a chop (WIN/LOSE/DRAW) next to that ratio. 10

11 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios of the company and its competitor, PlayGame Company Limited. Based on her workings, please advise your boss which one is better by putting a chop (WIN/LOSE/DRAW) next to that ratio. Profitability Possibly ME Video Game Co Ltd sells video games at a higher price! Ratios ME Video Or the Game purchase Co Ltdprice of PlayGame video game Co is Ltd lower than that of PlayGame Company! Gross Profit Ratio 25% 20% Net Profit Ratio 12.5% 12.5% Liquidity Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 11

12 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated accounting ratios of the company and its competitor, They PlayGame have Company the same Limited. Based on her workings, please advise your boss which one is better by putting a chop (WIN/LOSE/DRAW) next to that ratio. Profitability Gross Profit Ratio 25% 20% Net Profit Ratio 12.5% 12.5% Liquidity Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 12 It is rarely to have an equivalent NP ratio for different companies. proportion between the net profit figure and the sales figure for Ratios ME Video Game Co Ltd both PlayGame companies. Co Ltd

13 Activity 3: Case Study You are the financial manager of ME Video Game Company Limited. Your staff has calculated the accounting ratios and its competitor, PlayGame Company Limited. Based on the calculations, please advise management which company is better by chopping (WIN/LOSE/DRAW) the ratio. Profitability Ratios ME Video Game Co Ltd PlayGame Co Ltd Gross Profit RatioME Video Game 25% Co Ltd s current ratio of 20% 9 is far greater than required. It could be because too much money is lying idle or inventory levels are Net Profit Ratio 12.5% 12.5% high. Quick Ratios for ME is also higher than Liquidity necessary! ME may encounter bankruptcy risk! Current Ratio 9:1 4:1 Quick Ratio 4:1 1:1 13

14 Activity 3: Case Study Ratios Management Efficiency ME Video Game Co PlayGame Co Ltd Too much Ltd stock is lying idle! Beware of obsolete stock! Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital Employed 114 days 61 days 60 days 40 days 24% 34% 14

15 Activity 3: Case Study Ratios ME Not Video efficient Game in debt Co collection! PlayGame Co Ltd Poor credit controls Ltd may result in bad debts! Management Efficiency Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital Employed 114 days 61 days 60 days 40 days 24% 34% 15

16 Activity 3: Case Study Ratios Management Efficiency ME Video Game Co Ltd PlayGame Co Ltd Stock Turnover Rate 3 times 4.8 times ME settles accounts payable slowly and can have more \$\$\$ (working capital) for daily Credit Period Allowed to Debtors 114 operations! days 61 days Credit Period Received from Creditors Return on Capital Employed 60 days 40 days 24% 34% 16

17 Activity 3: Case Study Ratios Management Efficiency ME Video Game Co Ltd PlayGame Co Ltd Stock Turnover Rate 3 times 4.8 times Credit Period Allowed to 114 days 61 days Debtors ME has managed a lower return! Unable to make efficient use of resources to Credit Period Received 60 generate days income! 40 days from Creditors Return on Capital Employed 24% 34% 17

18 Summary of Lesson 1 Accounting Ratios Profitability Ratios Liquidity Ratios Management Efficiency Ratio Current Ratio Liquid Ratio Net Profit Ratio Gross Profit Ratio Stock Turnover Rate 18 Credit Period Allowed to Debtors Credit Period Received from Creditors Return on Capital Employed

19 Preparation for next lesson 19

20 Activity 4: Group Discussion and Presentation You are the financial controller of North Ltd or South Ltd. Your boss would like you to comment on the performance of the company with industry level and bring out the improvement directions and methods. Here are the industry ratios: Profitability Ratios Toy Industry Gross Profit Ratio 50% Net Profit Ratio 10% Liquidity Current Ratio 3:1 Quick Ratio 1.5:1 Management Efficiency Stock Turnover Rate Credit Period Allowed to Debtors Credit Period Received from Creditors 5 times 2 months 2 months 20 Topic Return A04 on Capital Employed 10%

21 Activity 4: Group Discussion and Presentation Here are the background of two companies: North Ltd: Target Customers: Teenager/infant/baby Price range: \$200 - \$500 Products: Basketball & football sportswear, Sports equipment, Trendy sports clothes Remarks: strong marketing strategies, invites Stars as spokespersons, advertises in different channels, good in design History: about 5 years South Ltd: Target customers: Adult/Elderly Price Range: above \$800 Products: Golf/Tennis/Casual sportswear, Golf/Tennis Equipment Remarks: many loyal high-class customers, good quality, suppliers give longer credit payment periods History: long history 21

22 Activity 4: Group Discussion and Presentation North Ltd: Group 1: Profitability Group 2: Liquidity Group 3: Management Efficiency 22

23 Activity 4: Group Discussion and Presentation South Ltd: Group 4: Profitability Group 5: Liquidity Group 6: Management Efficiency 23

24 Activity 4: Group Discussion and Presentation Conclusion Profitability North Ltd South Ltd Liquidity North Ltd South Ltd Management Efficiency North Ltd South Ltd 24

25 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! 25

26 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! 26

27 Activity 5: Debate Ratios analysis is the best method to evaluate financial performance! 27

28 Summary of Lesson 2 Ratio analysis has benefits and limitations. However, without ratios, comparisons are difficult to make between different financial statements and stakeholders do not have enough information for decision-making. With ratios, financial statements can be interpreted and applied to satisfy user requirements. So, ratio analysis is still the common method to effectively evaluate companies. 28

29 The End 29

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