Using the income statement and balance sheet constructed in (1) and (2), compute the following ratios. Compare the results with the industry averages. What strengths and weaknesses are apparent? ? RATIO INDUSTRY AVERAGE Current ratio 2:1 Acid test (quick ratio) 1:1 Inventory turnover a. annual sales 2.5 b. cost of goods sold 1.2 Receivables turnover a. annual credit sales 5.0x b. annual sales 6.0x Average collection period 75 days (days sales outstanding) Operating profit margin 26% Net profit margin 19% Return on assets 10% Return on equity 15% Debt/equity 33% Debt ratio (debt/total assets) 25% Times?interest?earned 7.1x ADDITIONAL INFORMATION:

Question

last year's inventory   $40,000 credit sales      $90,000

What will be an ideal response?

Answer 1

?Ratio analysis of financial statements?Current ratio:Current assets/Current liabilities$82,000/$41,000 = 2?Acid test (quick ratio):(Current assets ? inventory)/Current liabilities ($82,000 ? 42,000)/$41,000 = .976?Inventory turnover:Sales/Average inventory$100,000/[($42,000 + 40,000)/2] = 2.4orCost of goods sold/Average inventory$60,000/[($42,000 + 40,000)/2] = 1.5?Receivables turnover:Annual credit sales/Accounts receivable$90,000/$30,000 = 3orAnnual sales/Accounts receivable$100,000/$30,000 = 3.3?Average collection period (days sales outstanding):Receivables/ Credit sales per day =$30,000/($90,000/365) = 122 daysor$30,000/($90,000/360) = 120 days?Operating profit margin:Earnings before interest and taxes/Sales$25,000/$100,000 = 25%?Net profit margin:Earnings after taxes/Sales$16,800/$100,000 = 16.8%?Return on assets:Earnings after taxes/Assets$16,800/$172,000 = 9.8%?Return on equity:Earnings after taxes/Equity$16,800/$116,000 = 14.5%?Debt/Net worth ratio:   $56,000/$116,000 = 48.3%?Debt ratio:Debt/Total assets$56,000/$172,000 = 32.6%?Times?interest earned:Earnings before interest and taxes/Interest$25,000/$5,000 = 5.0?Times?interest earned (using net interest expense):Earnings before interest and taxes/Interest$25,000/($5,000 - 2,400) = 9.6
?Strengths: The current ratio, acid test, and inventory turnover are comparable to the industry averages. The operating profit margin exceeds the industry average. In general, the firm's financial performance is acceptable.?Weaknesses: There are two basic weaknesses. The first is the slow collection of accounts receivable which take 120 days to collect while the industry average is only 75 days. The firm is also using more financial leverage than the average firm as its debt ratio is 32.6 percent versus an industry average of 24 percent. This increased use of debt financing may be the result of carrying too many accounts receivable. If the firm were to collect its accounts receivable more rapidly, then it could retire some of its debt financing and reduce the debt ratio.?The increased use of debt financing could explain why the net profit margin is below the industry average. Since the operating profit margin is higher than the industry average, the lower net profit margin cannot be explained by the firm's operations. Either interest expense or higher taxes must be the source of the lower net profit margin. If the lower net profit margin is the result of higher interest expense, then this is probably the result of carrying too many accounts receivable.