Question

Question: Based upon your financial ratio analysis, what questions would you like to propose to management to gain clarity on the business operations?

Industry Financial Ratio Standards:

Ratio	Industry Norm	Milan Fashions Ratios 2015	Evaluation*
Current ratio	4.5 times	13.25	Good
Long-term debt-to-Equity ratio	12%	5.36%	Good
Debt-to-Equity ratio	30%	10.08%	Good
Total Debt ratio	20%	9.16%	Good
Financial leverage ratio	1.10	1.1	Fair
Inventory turnover	7 times	6 times	Poor
Fixed asset turnover	1.8 times	2.99 times	Good
Debt-to-Capital ratio	43.4%	10.32%	Good
Interest coverage ratio	5.0 times	18 times	Good
Return on Assets	8.4%	2.15%	Poor

Ratio	Industry Norm	Milan Fashions Ratios 2016	Evaluation*
Current ratio	4.5 times	21.54	Good
Long-term debt-to-Equity ratio	12%	6.92%	Good
Debt-to-Equity ratio	30%	9.86%	Good
Total Debt ratio	20%	8.97%	Good
Financial leverage ratio	1.10	1.1	Fair
Inventory turnover	7 times	6 times	Poor
Fixed asset turnover	1.8 times	2.6 times	Good
Debt-to-Capital ratio	43.4%	10.17%	Good
Interest coverage ratio	5.0 times	20 times	Good
Return on Assets	8.4%	2.22%	Poor

*Possible ratings: Good (Highest); Fair (Middle); Poor (Lowest)

Answer 1

Questions on all three ratings (Good, Fair and Poor) can be proposed to the management but to understand more on the business operations, we should first know the areas where major attention is required. It means, where the results are not as per the standard norms. Hence, questions are required to propose to Management on the "Poor" performance as reasons for such poor performance should be given more priority in order to understand more on business operations and based on it, action plan needs to be prepared for coming financial years.

By observing the above data, there are two ratios, one is Inventory Turnover Ratio and the second one is the return on assets ratio.

Before going with the questions, first understand these two ratios:

Inventory Turnover: This ratio measures relation between the cost of goods sold and average inventory on hand. It compares, how much cost of inventory is sold compare with available average inventory in a particular period to know how many times, the cost of goods is sold against its average inventory.

Formula: Inventory Turnover = Cost of Goods Sod/Average Inventory

Return on assets ratio: This ratio measures relation between the net income/earnings and average assets. It compares how much net income is generated by using the available assets invested in the business. This ratio is completely based on the performance of the company on how the company is performing with the available assets invested in business.

Formula: Return on assets = Net Income/Average Assets

Based on the requirement, the questions that should propose to the Management are as follows:

What are the possible reasons for not making the standard sales which results less cost of goods sold against the average inventory?

In order to improve the inventory turnover more than the industry norms in upcoming years, what measures should Management think to implement?

Why the company is not generating the profits compared to the assets invested in the business?

What measure will increase the returns/profits for the assets in the business?