Category: Accounting

The act of preparation of financial statements, reports, tax documents required by businesses and individuals in their dealings with the IRS, SEC and local and state authorities. Some statements included might be profit and loss, interim statement and balance sheets. Most accounting is done in accordance with GAAP (generally acceptable accounting principles)

What is Acid Test Ratio and ROA Ratio?


Investors calculate the acid test ratio, also known as the quick ratio or the pounce ratio. This ratio excludes inventory and prepaid expenses, which the current ratio includes, and it limits assets to cash and items that the business can quickly convert to cash. This limited category of assets is known as quick or liquid assets. The acid-text ratio is calculated by dividing the liquid assets by the total current liabilities.

This ratio is also known as the pounce ratio to emphasize that you’re calculating for a worst-case scenario, where the business’s creditors could pounce on the business and demand quick payment of the business’s liabilities. Short term creditors do not have the right to demand immediate payment, except in unusual circumstances. This ratio is a conservative way to look at a business’s capability to pay its short-term liabilities.

One factor that affects the bottom-line profitability of a business is whether it uses debt to its advantage. A business may realize a financial leverage gain, meaning it earns more profit on the money it has borrowed than the interest paid for the use of the borrowed money. A good part of a business’s net income for the year may be due to financial leverage. The ROA ratio is determined by dividing the earnings before interest and income tax (EBIT) by the net operating assets.

An investor compares the ROA with the interest rate at which the corporation borrowed money. If a business’s ROA is 14 percent and the interest rate on its debt is 8 percent, the business’s net gain on its capital is 6 percent more than what it’s paying in interest.

ROA is a useful ratio for interpreting profit performance, aside from determining financial gain or loss. ROA is called a capital utilization test that measures how profit before interest and income tax was earned on the total capital employed by the business.

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Reporting: Private vis-a-vis Public


A public corporation is a business whose securities are traded on the public stock exchanges, such as the New York Stock Exchange and Nasdaq. A private company is held solely by its owners and is not traded publicly. When the shareholders of a private business receive the periodical financial reports, they are entitled to assume that the company’s financial statements and footnotes are prepared in accordance with GAAP.

Otherwise the president of chief officer of the business should clearly warn the shareholders that GAAP have not been followed in one or more respects. The content of a private business’s annual financial report is often minimal. It includes the three primary financial statements – the balance sheet, income statement and statement of cash flows. There’s generally no letter from the chief executive, no photographs, no charts.

In contrast, the annual report of a publicly traded company has more bells and whistles to it. There are also more requirements for reporting. These include the management discussion and analysis (MD&A) section that presents the top managers’ interpretation and analysis of the business’s profit performance and other important financial developments over the year.

Another section required for public companies is the earnings per share (EPS). This is the only ratio that a public business is required to report, although most public companies report a few others as well. A three-year comparative income statement is also required.

Many publicly owned businesses make their required filings with the SEC, but they present very different annual financial reports to their stockholders. A large number of public companies include only condensed financial information rather than comprehensive financial statements. They will generally refer the reader to a more detailed SEC financial report for more specifics.