This is an auditing paper showing how to calculate the various financial ratios and how to interpret and analyse information using the. It also shows how to evaluate a company’s financial statements during an audit.
Q1
Current ratio is a ratio that measures the level of liquidity of a firm that allows it to meet debt obligations. A good current ratio should be above one showing current assets are more than the debt obligations. As far as our case study is concerned the current ratio is proper but it has a declining trend which is alarming as to the state of affairs in the company.
Debt to equity ratio is a capital structure analysis ratio that shows the level of capital that is borrowed as compared to owners’ equity. This ratio is expected to be around one or even less
But a higher ratio indicates that a company is in a lot of debt and may be unable to meet its financial obligation in the future as and when it is required. However, capital intensive companies such as our case study may have to rely on debt capital to finance investment in capital equipment but still the debt level should be closely monitored to avoid trouble in meeting future debt obligations.
Q2.
I disagree that the sales, accounts receivables and allowance for bad and doubtful debts are correctly stated.
According to the trend in the sales margin, there is a clear increase over the years. If this is compared to the trend in the sales level and profit level which have a trend of reducing over the years, this raises an alarm as to the authenticity of the financial statements.
Analysis of the accounts receivables
The ratio indicates the comparison of potential bad debts to the provision of bad and doubtful debts. For a sound company, the ratio should be around one, in our case it is quite above that and thus provision for bad and doubtful debts should be increased considerably.
Analysis of bad and doubtful debts
Comparative ratio = (Allowance for bad and doubtful debt)/ (Bad debt expense)
The comparative ratio is around 1 which can be interpreted to mean that the provision for bad and doubt debts is well estimated. Thus I agree it is correctly stated.
