Ratio Analysis

Module 1 Assignment 3: Ratio Analysis

Financial Management

Argosy University

Profit Margin:

27/795 = 0.0339 or 3.4%

Return on assets (investment)

Net income/total assets 27/450 = 0.06 or 6%

Net income/sales (times) sales/total assets

27/795 * 795/450 = 3.4% * 1.8 = 6.12%

Return on equity:

Net income(divide)stockholders’ equity

27/315 = 9%

Return on assets (investment)(divide)(1 – Debt/Assets)

0.06/1-135/450 = 0.06/1-0.3 = 9%

Receivables turnover:

Sales (credit)(divide)Receivables

795/66 = 12.0

Average collection period:

Accounts receivable/average daily credit sales

66/2 = 33

Inventory turnover:

Sales/inventory

795/159 = 5

Fixed asset turnover:

Sales/fixed assets

795/147 = 5

Total asset turnover:

Sales/total assets

795/450 = 1.77

Current ratio:

Current assets/current liabilities

303/111 = 2.73

Quick ratio:

Current assets – inventory/current liabilities

303 – 159/111 = 1.3

Debt to total assets:

Total debt/total assets

135/450 = 0.3%

Times interest earned:

Income before interest and taxes/interest

49.5/4.5 = 11

Fixed charge coverage:

Income before fixed charges and taxes/fixed charges

85.5/18 = 4.75

1. Calculate the following ratios/ interpret the results against the industry average listed from the problem given:

Justification for the ratios presented above:

The computed ratios above all display one element of how the business is operating. For example, Profit Margin in Sales is a tad bit higher than the industry average which means that it is stable but could be better due to it being so close to the average itself. In that regards, the business should look into methods for increasing sales and potentially setting higher sales goals for the business itself. The one ratio that does suffer quite a bit is the return on assets which is very low. This means that the business is not gaining profits off the assets it currently has. This could be due to higher operating costs of machinery, higher costs of rent, all of which once analyzed can be brought down to the industry average.

Talking about the return on assets previously, we can also look at how the inventory turnover relates to that in itself. The ratio is 5x against the industry average of 10x. Based on what I have learned from previous courses, I could assume that this company is not turning over inventory as quickly as they should. This will then amount to higher inventory costs and money that could be made if once again sales increased and inventory was pushed out much sooner than later. Another reason that it is below the industry average could be due to excessive manufacturing of inventory itself. Producing more than the business can sell would surely cause a lower turnover rate. Management at this point should consider lowering inventory and only holding what they know they could sell. This will prevent extra expenses and produce more positive numbers for the company.

Lastly, for the most part, this business is operating at standards or above them slightly as they have more ‘Good’ than ‘Low’ or ‘Poor’. The interest earned, current ratio and quick ratio are all acceptable and above industry average as listed above. The only issue I can conclude as I mentioned before was possibly setting new sales goals, and producing less inventory to sustain more profits or excessive costs.