Question

Please review the following six ratios for Simpson Company and ABC Inc. for the year ended 2014, then address the two questions below.

Ratio Name	Simpson Company	ABC Inc.
(a) Days’ Sales Outstanding	36	30
(b) Inventory Turnover	5.6	4.9
(c) Asset Turnover	2.02	3.03
(d) Earnings per Share	$1.50	$1.25
(e) Times Interest Earned	6.1	5.2
(f) Return on Common Stockholders’ Equity	15.6%	12.2%

Instructions: This is a two-part question. (1) Explain the meaning of each of the Simpson Company ratios above. (18 points) (2) State which company performed better for each ratio. (18 points)

Answer 1

Simpson Company and ABC Inc.
a.Days’ Sales Outstanding
Days sales outstanding is calculated as = 365 days / (Sales / Avg. Accounts Receivable)
The figure arrived shows how efficiently or inefficiently the companies are converting
Receivables into cash .It is the average number of days the company takes to convert
debtors into cash.The faster the better for liquidity.The company which converts
debtors into cash faster are more efficient.
Simpson Company takes 36 days to convert debtor into cash whereas ABC inc. takes
30 days which shows Abc Inc. is more efficient in converting debtors into cash.
b.Inventory Turnover
Inventory Turnover is calculated as = Cost of goods sold / (Avg. inventory)
The Inventory needs to be moved quickly to remove obsoletion and reduce storage
costs.The longer the inventory lies idle the higher the cost.This ratio shows how many
times Inventory has been replaced and sold.Th esame figure can be used by dividing
by days in the period to calculate the days it takes to sell the inventory on hand.
The lower the ratio higher the number of days to sell the inventory on hand.
Simpson Co. seems to sell their inventory faster than ABC inc.
(c) Asset Turnover
Asset Turnover is calculated as = Sales / Avg. Total assets
Assets are used to generate sales revenue.The asset turnover ratio measures the
efficiency of a company's use of assets in genrating sale revenue.
Lower the asset turnover ratio higher the profit margin.Higher the Asset turnover
ratio lower the profit margin.
ABC Inc. with high asset turnover is using its assets efficiently to generate maximum sales
(d) Earnings per Share
Earning per share is calculated as = Net income / Total no. of shares outstanding
Higher EPS indicates significant dividends for investors .It gives a good return to
the shareholders
Simpson Co. has higher EPS indicating good return to shareholders than ABC Inc.
(e) Times Interest Earned
Times Interest earned is calculated as = Earnings before interest & Tax / Interest Expense
This ratio shows the company's ability to meet its debt obligation.The higher the ratio
higher the ability to meet its debt obligation.
(f) Return on Common Stockholders’ Equity
Return on Common Stockholders’ Equity is calculated as = Net Income / common stockholders' equity
The ratio measures ability of company in generating income for its common stock holders.Higher
the ratio better the performance.