Question

a. Does Werner Beauty seem to prefer to finance its assets with debt or with equity?

b. A supplier to Werner Beauty sells merchandise to them and asks to be paid within 60 days. While any of Werner Beauty’s financial ratios might be of interest to the supplier, which of the ratios listed below do you think would likely be the most important one to the supplier?

c. Which of the ratios presented suggest that, compared to its industry, Werner Beauty may have a problem controlling its operating expenses?

Data for Werner Beauty and its industry.

Financial Ratios Werner Beauty Industry

Current ratio. 2.1 0.9

Quick ratio 1.9 0.5

Inventory turnover 6.1 X 5.8 X

Operating profit margin 10.1% 13.0%

Debt ratio. 41.5% 25.9%

Return on equity 20.6% 17.4%

Answer 1

a. From Debt ratio -41% we can say the proportion of long term loan should not be more than 41% of the total funds. A large proportion of total assets is provided by equity and hence the firm is less dependent on external source of finance. More than 50% of Assets are financed by Equity in Werner Beauty.

b. Creditor or Supplier of the Werner Beauty might be interested in Inventory turnover,company's profitability ratio and Current Ratio.

Inventory turnover ratio indicates whether stock has been efficiently used or not. It shows the speed with which the stock is turn into sales during the year. The higher the ratio the better it is, since it indicates that stock is selling Quickly which will result prompt payment recieved to Supplier or Creditors. As soon as inventory turn into Sales it will help company to make payment to necessary parties with the Revenue recieved from the Sales.

Current Ratio shows company ability to meet its short term obligation with its most Current Assets. Werner Beauty has Current Ratio 2:1 which is considered to be the standard ratio it shows sufficiency of liquidity and no shortage of working capital result Werner Beauty ability to pay its creditor/Suppliers easily.

Return on Equity and Operating Profit Margin measures the overall efficiency of the business operations. An increase in this ratio over the previous year shows improvement in the overall efficiency and profitability of the business and credit worthiness.

c. From the given ratio the only Ratio which is less than Industry Ratio (13%)is Operating Profit Margin (10.1%).

Ratio	Werner Beauty	Industry
Current Ratio	2.1	0.9
Quick Ratio	1.9	0.5
Inventory turnover	6.1x	5.8x
Operating Profit Margin = Operating Profit/ Sales ×100	10.1%	13%
Debt Ratio	41.5%	25.9%
Return on Equity	20.6%	17.4%

The Operating Profit Margin ratio measures the rate of Operating Profit earn on Sales. It helps in determining the overall efficiency of the business operations. An increase in the ratio over the previous year shows improvement in the overall efficiency and profitability of the business.

Operating Profit Margin is just 10.1% is quite low as it will leave lower margin profit on sales and extend of sales is absorbed by the Cost od Goods sold and Operating Expenses.