QUESTION ONE
a) The current ratio increase is a favourable indication as to liquidity, but alone tells little about the going concern prospects of the client. From this ratio alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The decline in the quick ratio to 0.8 is an unfavourable indication as to immediate liquidity, especially when the current-ratio increase is also considered. This decline is also unfavourable because it reflects a declining cash position and raises questions as to reasons for the increases in other current assets, such as inventories.
The cash debt coverage ratio is a solvency ratio that indicates a company’s ability to repay its liabilities from cash generated by operations. Since this ratio declined during 2013, it indicates that the company’s cash provided by operations decreased and/or its liabilities increased. The asset turnover and earnings per share ratio indicate profitability. Since both ratios are higher in 2013, it is likely that the company’s sales revenue is increasing. Increases in sales and profit are favourable for going-concern prospects. It is most likely that there has been no change in the number of issued ordinary shares (although more information is necessary to make this judgement). This, in turn, indicates that financing was not obtained through the issue of ordinary shares.
b) The collective implications of these data alone are that the client entity is about as solvent at the end of the current year as it was at the beginning, although there may be a need for short-term operating cash.
Creditors should however seek further information. The creditors should evaluate conclusions drawn from ratio analysis in light of the current status of, and expected changes