FAQs on Concept & Classification of Accounting Ratios Video Lecture - Accountancy Class 12 - Commerce
|1. What is the concept of accounting ratios?
Ans. Accounting ratios are mathematical expressions that are used to analyze and interpret financial statements. They provide a quantitative measure of the relationship between different financial variables, such as assets, liabilities, income, and expenses. Accounting ratios are used to assess the financial health and performance of a business and to make informed decisions.
|2. How are accounting ratios classified?
Ans. Accounting ratios are classified into four main categories: liquidity ratios, profitability ratios, activity ratios, and solvency ratios.
- Liquidity ratios measure a company's ability to meet its short-term obligations and include ratios such as the current ratio and quick ratio.
- Profitability ratios evaluate a company's ability to generate profits and include ratios such as the gross profit margin and return on equity.
- Activity ratios assess a company's efficiency in managing its assets and include ratios such as inventory turnover and accounts receivable turnover.
- Solvency ratios measure a company's long-term financial stability and include ratios such as debt-to-equity ratio and interest coverage ratio.
|3. How can accounting ratios help in financial analysis?
Ans. Accounting ratios play a crucial role in financial analysis as they provide insights into a company's financial performance, liquidity, profitability, and overall financial health. By comparing ratios over time or against industry benchmarks, analysts can identify trends, strengths, and weaknesses in a company's financial position. This information can help in making informed decisions, such as assessing creditworthiness, evaluating investment opportunities, and identifying areas for improvement.
|4. What are the limitations of accounting ratios?
Ans. While accounting ratios are valuable tools for financial analysis, they have certain limitations. Some of the limitations include:
- Reliance on historical data: Accounting ratios are based on past financial statements, which may not reflect the current or future performance of a company.
- Subjectivity: Different companies may have different accounting policies, making it challenging to compare ratios across industries or companies.
- Lack of qualitative factors: Accounting ratios only provide a quantitative analysis and do not consider qualitative factors such as management competence, industry trends, or economic conditions.
- Limited comparability: Ratios may not be comparable across companies of different sizes, industries, or geographical locations.
|5. How can accounting ratios be used to assess a company's financial stability?
Ans. Solvency ratios, such as the debt-to-equity ratio and interest coverage ratio, can be used to assess a company's financial stability. These ratios measure a company's ability to meet its long-term obligations and manage its debt. A lower debt-to-equity ratio indicates lower financial risk, as it shows that the company is relying less on borrowed funds. Similarly, a higher interest coverage ratio indicates that the company has sufficient earnings to cover its interest expenses. By analyzing these ratios, investors, creditors, and stakeholders can evaluate the financial stability of a company and its capacity to repay debts.