South Regional CheapO Quality Heavy Duty Electric Burger Software Machinery Curr
ID: 2695511 • Letter: S
Question
South Regional CheapO Quality Heavy Duty Electric Burger Software Machinery Current Ratio 0.9 1.4 7.1 3.9 Quick Ratio 0.8 0.9 5.2 2.8 Debt Ratio 71% 50% 0% 36% Net Profit Margin 6.5% 13.2% 26.9% 9.0% o What are the difficulties in comparing the ratios of these companies to one another? o Why are the liquidity ratios for the utility and fast food companies so much different from the software and machinery manufacturing company? o Would it be advisable for the software company to carry the same debt ratio as the utility company? Why or why not? o Make a recommendation to Steven regarding these investment choices. Based on these ratios, what is your advice? If another student makes different suggestions, challenge them to justify their choices.Explanation / Answer
Limitations of ratio analysis
1. Accounting Information
* Different Accounting Policies
The choices of accounting policies may distort inter company comparisons. Example - IAS 16 allows valuation of assets to be based on either revalued amount or at depreciated historical cost. The business may opt not to revalue its asset because by doing so the depreciation charge is going to be high and will result in lower profit.
* Creative accounting
The businesses apply creative accounting in trying to show the better financial performance or position which can be misleading to the users of financial accounting. Like the IAS 16 mentioned above, requires that if an asset is revalued and there is a revaluation deficit, it has to be charged as an expense in income statement, but if it results in revaluation surplus the surplus should be credited to revaluation reserve. So in order to improve on its profitability level the company may select in its revaluation programme to revalue only those assets which will result in revaluation surplus leaving those with revaluation deficits still at depreciated historical cost.
2. Information problems
* Ratios are not definitive measures
Ratios need to be interpreted carefully. They can provide clues to the company
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