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Discuss the importance of the following financial statements to the management of a business enterprise - Leaving Cert Business - Question 6 - 2001
Question 6
Discuss the importance of the following financial statements to the management of a business enterprise. (i) The Profit and Loss Account. (ii) The Balance Sheet. ... show full transcript
Worked Solution & Example Answer:Discuss the importance of the following financial statements to the management of a business enterprise - Leaving Cert Business - Question 6 - 2001
Step 1
The Profit and Loss Account
Answer
The Profit and Loss Account (P&L) is crucial for the management of a business enterprise as it summarizes the revenues and expenses during a specific period. This statement provides insights into the operational efficiency by illustrating profitability, thereby helping management make informed decisions on budgeting, performance evaluation, and strategic planning. Monitoring the P&L can also identify trends, allowing management to adapt to economic changes.
Step 2
The Balance Sheet
Answer
The Balance Sheet offers a snapshot of a company's financial position at a specific date, detailing assets, liabilities, and equity. It's essential for assessing the liquidity and solvency of the enterprise. Management can use this information to evaluate capital structure and make strategic financial decisions. It also helps stakeholders understand the overall financial health and stability of the business.
Step 3
Calculate for 1999 and 2000 the Acid Test Ratios and the Debt Equity Ratios
Answer
To calculate the Acid Test Ratio:
Acid Test Ratio = ( \frac{Current Assets - Closing Stock}{Current Liabilities} )
For 1999: ( \frac{90,500 - 47,300}{65,100} = \frac{43,200}{65,100} \approx 0.66 )
For 2000: ( \frac{75,400 - 51,200}{44,600} = \frac{24,200}{44,600} \approx 0.54 )
To calculate the Debt Equity Ratio:
Debt Equity Ratio = ( \frac{Long Term Debt}{Equity Share Capital} )
For 1999: ( \frac{150,000}{240,000} = 0.625 )
For 2000: ( \frac{220,000}{240,000} = 0.9167 )
Step 4
Analyse any trends you notice from your calculations
Answer
From the calculations:
- The Acid Test Ratio decreased from 0.66 in 1999 to 0.54 in 2000, indicating a decline in liquidity, meaning the company may be less capable of covering its short-term liabilities with liquid assets.
- The Debt Equity Ratio increased from 0.625 to 0.9167, suggesting that the company has relied more heavily on debt financing, which could indicate increased financial risk. This trend could prompt the management to reassess its financing strategy to ensure long-term sustainability.