N5 Entrepreneurship


PAUSE FOR THOUGHT If the ratio is too low, you may be in trouble if you have to pay all current debt in a short period. • Acid test


The acid test or quick ratio concentrates on the really liquid assets (the bottom ones in the diagram) and therefore stock is deducted from current assets. A ratio of 1:1 is acceptable because it means that the business has enough quick assets (cash & stock) to cover the current liabilities in an emergency. This test will indicate whether your business can meet its current obligations if all sales income disappeared suddenly and you had to pay your creditors (suppliers). If the ratio is below 1:1, you will have to collect debtors’ accounts or stop granting credit for a certain period to allow money to flow into your business. However, that might be too late; you could lose your business in that way.


Acid test ratio = =


Current assets 3 minus stock 5 Current liabilities 4


R11 500 – R1500 R3770


3.3.3 Activity ratios


• Debtors turnover ratio (Accounts receivable) This ratio is a measure of how many times a business’s debtors have been turned into cash during the year. It also indicates the average number of days it takes to collect an account. This can be compared to the credit terms you extend to your debtors to indicate the efficiency of your credit and collection policies in your business.


Debtors turnover rate (Accounts receivable)


Average collection period = =


Average credit sales Average Debtors


365 Debtors turnover rate


• Inventory turnover ratio This ratio indicates the number of times on average a business has sold its entire inventory or stock during the year. This will help a business to determine whether you are perhaps carrying too much stock. There are no guidelines here to help you except to try to increase the number compared to the previous year. A further calculation will indicate the number of days it takes to sell the whole inventory once. It is calculated as follows:


Opening debtors + Closing debtors ÷ 2 (The same with credit sales)


= 2.65 ➔ 2.65 : 1


Stock implies both product


and raw materials


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