PM Chapter 15 Questions Financial Performance Measurement
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Are shareholders funds and retained earnings the same thing?
No. Shareholders funds includes share capital and all reserves (not just retained earnings).
Hi John, for question 4 how does a NCL loan increase gearing? the double entry would net off in the BS Dr Cash or Dr NCA and Cr NCL
The double entry is not relevant.
The long-term debt increases and the equity does not change. So there is an increase in the gearing.
Do watch my free lectures on this again 🙂
Thank for the explaining on question 5
no 5 answer please
You can see the answers by hovering over the question when you receive the quiz.
The current ratio will decrease; the quick ratio will not change; the inventory days will decrease; the gearing will increase.
Good day Sir
Question 5
How does writing off inventory , not effect the quick ratio , as this results in lower inventory , therefore the assumption is that it would affect the ratio.
Secondly
Gearing ratio is based on long term liability over shareholders funds ,
therefore writing off inventory reduces current assets , how does that have an effect to shareholders funds.
Kindly assist sir
1. The quick ratio does not include inventory (as explained in my free lectures).
2. Writing off inventory reduces the assets and reduces the shareholders funds (equity). Lower equity means a higher gearing ratio.
Dear Sir,
On Q5, I do not understand how change in inventory will affect gearing.
Thanks,
Beatrice
Writing off inventory will decrease the profit. This will reduce the retained earnings and therefore the total value of the equity (share capital plus reserves). A lower value for the equity will mean that the gearing ratio is higher.
Sir, In question 4 Taking a long term loan Increases our Bank or cash in Current assets Right? Shouldn’t the increase in the “numerator” of the current ratio lead to an increase in the Current Ratio??
The question says that they are taking the loan so as to buy a non-current asset. So the cash will end up not increasing at all.
Thank you Sir, Crystal clear now !! ?
Great 🙂
won’t raising a long term loan in order to buy an asset increase the current liabilities?(assuming we have to pay interest each year on loan)
I assume that you are referring to question 4.
In a years time when the interest falls due the current ratio may well be affected. However simply taking a long-term loan has no affect on the current ratio when the loan is taken.
Hello can you explain, how will writing off inventory not have any effect on Quick ratio? Thank you!
Inventory is not included in the calculation of the quick (acid-test) ratio. This is explained in the free lectures.
Sir, In question 2,
Don’t we need figure of inventory to calculate inventory days from the statement of financial position?
So only ROCE would be the answer right? (Also, ROCE is an answer because it can also be calculated by asset turnover ratio and net profit margin, right?)
Oh sorry, I think I misread the question. Kindly apologise.
Please answer my second question!
However we calculate the ROCE we need to know the profit for the year and this comes from the SOPL, not from the SOFP.
Sir, one question was what will be the effect on Current Ratio if long term loans are increased..
so as per my understanding if long term loan is increased that means cash is inflow and therefore the CA should increase…
please correct me if wrong
Hello Sir,
Can you please a bit explain how Gearing ratio is affected by Inventory ?
Sir.., I am confusing about Q3. ROCE
ROCE = Profit before interest and tax/ Capital Employed
So
PBIT/CE = Asset Turnover X GP Margin
PBIT/CE = Sale/ CE X Gross profit (PBIT)/ Sale
So.. should use gross profit right..?
please kindly let me know why use net profit margin. Thank so much in advance
The net profit for management purposes is the profit before interest and tax. I explain why this is the case in my free lectures on this.
Sir, there is two gearing ratio. 1. debt/EQUITY. 2.DEBT/DEBT+EQUITY,
How we know which ratio is required in question, as in question 4 the first ratio is required.
Question 4 does not require the first ratio. If there is more debt then the gearing will always increase whichever of the two measures is used.
If in the exam you are required to actually calculate the ratio then the question will make it clear which way it is to be measured.
THANK YOU SIR.
Sir, may I ask what does it meant by written off inventory?I was quite confused about that.
Thanks in advance.
Writing off inventory is reducing its value to zero (presumably because it was no longer fit to be sold).
Do we get these ratios on a formula sheet during the exam?
no please
No you don’t. The formulae that you are given in the exam are on the formula sheet that is printed near the front of our free lecture notes.
sir i have a confusion. as gearing is also measured by the formula Total assets-current liabilities. in Qs 5 as we write of inventory it results in decrease of total assets so gearing should decrease…then why is the correct answer increasing ?
Gearing is not measured as total assets minus current liabilities!!
It is measured as long-term debt divided by equity plus long-term debt. Equity plus long-term debt is equal to total assets less current liabilities. If inventory is written off then total assets less current liabilities decreases. Since this is the denominator in the formula for the gearing ratio, the gearing ratio will increase.
Thank you so much for clarifying 🙂
You are welcome 🙂
Write off inventory question Nr 5 – The correct answer is ‘Increase Gearing Ratio’.
Please can you advise how write off inventory can influence gearing ratio?
For number 5 how does the write off of inventory increase the gearing ratio?
Writing off inventory will reduce the profit, which in turn reduces the total equity. Therefore the gearing will increase.
Thank you for clarifying 🙂
You are welcome 🙂