(a) Accounting ratios (b) Eplain the following i. Accounting ratios ii. Current ratio iii. Rate of stock turnover iv. Return on capital employed v. Average ...

(a) and (b) Accounting ratios explained

1. Accounting ratios: mathematical relationships between two related figures in the financial statements, used to measure and interpret a firm's profitability, liquidity, efficiency and financial position.
2. Current ratio \( = \dfrac{\text{Current assets}}{\text{Current liabilities}} \). It measures short-term liquidity - the ability to meet current obligations as they fall due (a level around 2:1 is often regarded as satisfactory).
3. Rate of stock turnover \( = \dfrac{\text{Cost of goods sold}}{\text{Average stock}} \). It shows the number of times, on average, stock is sold and replaced during a period; a higher rate suggests brisk trading.
4. Return on capital employed (ROCE) \( = \dfrac{\text{Net profit}}{\text{Capital employed}} \times 100 \). It measures how efficiently the capital invested is used to generate profit.
5. Average collection period \( = \dfrac{\text{Debtors}}{\text{Net credit sales}} \times 365 \). It shows the average number of days debtors take to settle their accounts.
6. Gross profit percentage \( = \dfrac{\text{Gross profit}}{\text{Net sales}} \times 100 \). It measures the profitability of trading before deducting operating expenses.

(c) Importance of accounting ratios

• They measure profitability, liquidity and operating efficiency.
• They allow comparison of performance over time and between businesses.
• They assist management in planning, control and decision-making.
• They help investors and lenders judge the safety of their money.
• They reveal the solvency and financial strength of the business.
• They highlight trends, strengths and weaknesses for corrective action.