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ACC 205 Week 1 Balance Sheet Journal

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Accounting

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ACC 205 Week 1 Balance Sheet Journal
ACC 205 Week 1
Balance Sheet Journal

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ACC 205 Week 1 Balance Sheet Journal
Balance Sheet Ratios
Balance sheet ratios
The important ratios that arise from the Balance Sheet include working
capital, liquidity, net worth, debtors turnover, return on assets and return
on investment.
Working capital ratio
This ratio is also known as "the current ratio", and is one of the best-
known measures of financial strength. The main question this ratio
addresses is: "Does your business have enough current assets to meet
the payment schedule of its current debts with a margin of safety for
possible losses in current assets, such as stock shrinking or
uncollectable debtors?"
A generally acceptable current ratio is 2:1; but whether or not a specific
ratio is satisfactory, depends on the nature of the business and the
characteristics of its current assets and liabilities. The minimum
acceptable current ratio is obviously 1:1 but that relationship is usually
playing it too close for comfort.
Because there is a time lag between paying for materials and labour
used to produce your goods and the receipt of the cash for those goods,
the business needs money to fund its day-to-day operations. This money
is referred to as working capital and is represented by the difference
between current assets and current liabilities.
The formula for working out your working capital ratio is as follows:

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ACC 205 Week 1 Balance Sheet Journal
Current Assets ($120,000) / Current Liabilities ($80,000) = 1.5 : 1.0
In this case it means that there is $1.50 available in current assets to
meet every $1 of current liability.
This ratio is used by lenders as a guide to the soundness of a business
because the greater the excess of current assets over current liabilities
the better the position that the business is in to meet its commitments at
least in the short term. Here are some of the things that you could do if
you feel that your current ratio is too low:
• Pay off some debts.
• Increase your current assets by borrowing for periods of more than one
year.
• Convert non-current assets into current assets.
• Increase your current assets from taking in new equity contributions.
Put profits back into your business, rather than drawing them out by
way of salaries etc.
Liquidity ratio
This ratio is also called "the quick ratio", and is known as the "acid test
ratio" because it is one of the best measures of liquidity. This ratio is
used to determine the solvency of your business or its ability to meet its
immediate commitments. The liquid ratio is a much more exacting
measure than the current ratio. By leaving out stocks and other non-cash
assets, it concentrates clearly on assets that are liquid with a value that
is fairly certain. It will answer the question of: "If all sales revenue should
disappear, could my business meet its current obligations with the funds
on hand or that can be easily accessed?" A ratio of 1:1 is considered
satisfactory unless the majority of your quick assets are in debtors and
there is a pattern of debtors lagging behind rather than paying their
accounts on time. It is often referred to as the acid test. In calculating
this ratio it is important to bring in only those current assets that are in
cash or can be converted readily into cash. Similarly current liabilities
brought in must only be those that need to be met quickly.
The formula for this ratio is:

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