1. Analysis and Interpretation Financial Stability
YEAR 11 ACCOUNTING
Analysis and Interpretation
Financial Stability

2. CLASSIFICATION OF RATIOS/PERCENTAGES
We are looking at this today!!!

3. How to evaluate businesses’ results?
Please follow the steps as follows:
Calculate Percentages/Ratios
Explain the meaning of the Percentage/Ratios
Unsatisfactory Trend
Look at the financial statements and formula and identify what has been changed?
Identify the trend
Satisfactory Trend
Look at the financial statements and formula and identify what has been changed?
Why was there a change in the financial statements?
Provide a recommendation/s to overcome the unsatisfactory trend.
Why is there a change in the financial statements?

4. Financial Stability Financial Stability means:
The level of stability a business has on continuing its operation into the foreseeable future in terms of the weighting between equity and liability.

5. Measures of Financial Stability
The following analysis is classified under financial stability:
Equity Ratio

6. EQUITY RATIO BENCHMARK 0.6:1
Meaning: It means for every $1 of total assets, XX cents is FINANCED by the owner.
The result shows the business IS/IS NOT facing pressure of repaying debt and has GREATER/LESS chance of accessing external funds.

7. Example
If the equity ratio shows 0.70:1. This means for every $1 of total assets, 70 cents is FINANCED by the owner.
This result shows that the business is NOT facing pressure of repaying debts and are ABLE to access further external funds.

8. Equity Ratio in a Pie Chart
The business is NOT facing pressure of repaying debts and the business is NOT facing a risk of to be controlled by external parties, such as bank.

9. Calculation 2005 2006 ASSETS Current Assets 4,000 3,000
Non Current Assets (PPE)
30,000
34,000
40,000
43,000
LIABILITIES
Current Liabilities
3,800
5,000
Non Current Liabilities
10,000
13,800
15,000
20,000
NET ASSETS
20,200
23,000

10. Calculation 2005 2006 EQUITY Capital – 1 April 40,000 20,200
Plus: Net Profit
10,000
25,000
50,000
45,000
Less: Drawings
29,800
22,000
Capital – 31 March
23,000

11. Calculation
2005
2006
Equity Ratio

12. Satisfactory/Unsatisfactory Ratio
The Equity Ratio in 2006 showed a
SATISFACTORY or UNSATISFACTORY result.
The next step is to describe the reason,
using the Balance Sheet.

13. Identify the Trend The Equity Ratio showed a
SATISFACTORY or UNSATISFACTORY trend.

14. Reason (surface level)
Despite Equity showing an increasing trend, the growth rate of liabilities is faster than the growth rate of equity, which means more assets are financed by outsiders.
Liabilities
Equity Ratio
Equity

15. Reason (deep level)
The reason that a higher growth rate of liabilities occurred:
The business purchased more property, plant and equipment by borrowing a long term loan instead of an owner’s contribution. (Look at the Balance Sheet)

16. Other situations that causes an equity ratio to show an unsatisfactory result
When the owner withdraws excess cash or goods from the business (More drawings, Less Cash)
When the business has bought its assets ALL on credit.
When the business has made a loss during a financial year.

17. Recommendations Cause Recommendation
When the owner withdraws excess cash or goods from the business (More Drawings, Less Cash)
Reduce the level of drawings, this will keep more owner’s funds in the business.
When the business has bought its assets ALL on credit.
If sufficient cash is available, try to finance the asset purchase by using some of the business’s cash.
When the business has made a loss during a financial year.
Check the expenses, review the mark-up policy etc.