Business – 10.4 Finance and accounting strategy – Accounting data and ratios | e-Consult
10.4 Finance and accounting strategy – Accounting data and ratios (1 questions)
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Model Answer:
- Profitability ratios:
- Return on Equity (ROE) – An increase in dividends reduces retained earnings, which lowers shareholders’ equity. With profit unchanged, ROE (Profit ÷ Equity) will rise, giving the appearance of higher efficiency, even though the underlying profit generation has not improved.
- Return on Assets (ROA) – If the dividend increase is funded by using cash reserves rather than borrowing, total assets fall. With profit unchanged, ROA (Profit ÷ Assets) will increase. However, if the company borrows to fund the higher dividend, assets rise and ROA may fall.
- Liquidity ratio:
- Current Ratio – Paying larger dividends reduces cash and possibly other current assets. Assuming current liabilities stay constant, the current ratio (Current Assets ÷ Current Liabilities) will decline, indicating weaker short‑term liquidity.
Overall, a higher dividend payout can improve profitability ratios through a lower equity base but may deteriorate liquidity because cash is depleted.