Question

Use the following information to answer the questions below: note: all sales are credit sales Income Stmt info: 2016 2017 Sales $ 975,000 $        1,072,500 less Cost of Goods Sold: 325,000 346,125 Gross Profit 650,000 726,375 Operating Expenses 575,000 609,500 Earnings before Interest & Taxes 75,000 116,875 Interest exp 25,000 31,000 earnings before Taxes 50,000 85,875 Taxes 20,000 34,350 Net Income $ 30,000 $              51,525 Balance Sheet info: 12/31/2016 12/31/2017 Cash 60,000 $ 63,600 Accounts Receivable 80,000 $ 84,000 Inventory 110,000 $ 126,500 Total Current Assets $ 250,000 $ 274,100 Fixed Assets (Net) $ 300,000 $ 312,000 Total Assets $ 550,000 $ 586,100 Current Liabilities $            130,000 $            149,500 Long Term Liabilities $            150,000 $            170,000 Total Liabilities $            280,000 $            319,500 Stockholder's Equity $            270,000 $            266,600 Total Liab & Equity: $            550,000 $            586,100

Compute each of the following ratios for 2016 and 2017 and
indicate whether each ratio was getting "better" or "worse" from 2016 to 2017
and whether the 2017 ratio was "good" or "bad" compared to the Industry Avg
(round all numbers to 2 digits past the decimal place)

	2016	2017	Getting Better or Getting Worse?	2017 Industry Avg	"Good" or "Bad" compared to Industry Avg
Profit Margin				0.09
Current Ratio				1.80
Quick Ratio				1.12
Return on Assets				0.18
Debt to Assets				0.60
Receivables turnover				12.00
Avg. collection period*				22.10
Inventory Turnover**				8.25
Return on Equity				0.16
Times Interest Earned				8.15
*Assume a 360 day year
**Inventory Turnover can be computed 2 different ways. Use the formula listed in the text
(the one the text indicates many credit reporting agencies generally use)

Answer 1

	2016	2017	Getting Better or Getting Worse?	2017 Industry Avg	"Good" or "Bad" compared to Industry Avg
Profit Margin	0.03	0.05	Better	0.09	Bad
Current Ratio	1.92	1.83	Worse	1.80	Good
Quick Ratio	1.08	0.99	Worse	1.12	Bad
Return on Asset	0.05	0.09	Better	0.18	Bad
Debt to Assets	0.51	0.55	Worse	0.60	Good
Receivables Turnover	12.19	12.77	Better	12.00	Good
Average Collection Period	29.53	28.19	Better	22.10	Bad
Inventory Turnover	8.86	8.48	Worse	8.25	Good
Return on Equity	0.11	0.19	Better	0.16	Good
Times Interest Earned	3.00	3.77	Better	8.15	Bad

Explanation:

Profit Margin

Profit Margin = Net Income / Sales

For 2016,

Profit Margin = 30,000 / 975,000

= 0.03077

For 2017 ,

Profit Margin = 51,525 / 1,072,500

   = 0.048

Profit Margin measures how much profit is earned from every dollar of sales. The higher the profit margin the better the position of the company.

As the ratio increased from 0.03 in 2016 to 0.05 in 2017 , the ratio was getting better from 2016 to 2017

But the ratio is less than the industry average of 0.09. So the ratio is bad compared to industry average.

Current Ratio

Current Ratio = Current Assets / Current Liabilities

For 2016,

Current Ratio = 250,000 / 130,000

= 1.92

For 2017,

Current ratio = 274,100 / 149,500

   = 1.83

Higher current ratio means, the company has more current assets (assets which are expected to generate cash in a year) to meet its current liabilities ( short term obligations to be met within a year). So higher ratio indicates better financial position of the company. The current ratio decrease from 2016 to 2017. So it became worse.

The current ratio is greater as compared to industry average of 1.80. So the ratio is good compared to industry average.

Quick Ratio

Quick Ratio = ( Cash+ Accounts Receivables) / Current Liabilities

For 2016,

Quick Ratio = (60,000 + 80,000) / 130,000

= 1.077

For 2017,

Quick Ratio = (63,600 + 84,000) / 149,500

   = 0.987

Quick ratio shows ability of a company to meet its short term obligations ith its quick assets. Cash, Cash equivalents, marketable securities and accounts receivables are considered to be quick assets, which means they are more liquid and easily covertable to cash. Inventory is considered to be less liquid. Higher quick ratio means company has more liquid assets to meet current obligations. The higgher the ratio the better.

The ratio decreased from 2016 to 2017 . So the ration became worse.

The ratio is less than the industry average of 1.12. So the ratio is bad compared to industry average.

Return on Assets

Return on Assets= Net Income / Total assets

For 2016,

Return on Assets= 30,000 / 550,000

= 0.054

For 2017,

Return on Assets = 51,525 / 586,100

   = 0.088

Return on Asset measures how much profit is generated from each dollar of asset. The more the ratio the better.

The ratio has increased from 2016 to 2017. So the ratio has become better.

The ratio is much lesser than the industry average of 0.18. So ratio is bad compared to industry average.

Debt to Assets

Debt to Assets = Total Liabilities / Total assets

For 2016,

Debt to Assets = 280,000/ 550,000

= 0.51

For 2017

Debt to assets = 319,500 / 586,100

= 0.545

This ratio indiactes leverage. It indicates percentage of total asset which is financed by creditors. A lower ratio shows better financial position of the company.

The ratio increases from 2016 to 2017. So it has become worse from 2016 to 2017

The ratio is less than the industry average of 0.60. this means the ratio is good compares to industry average

Receivables turnover

Receivables turnover = Credit sales/ Accounts receivables

For 2016,

Receivables turnover = 975,000 / 80,000

   = 12.19

For 2017,

Receivables turnover = 1,072,500 / 84,000

   = 12.77

The ratio shows how efficiently the firm collects it accounts receivable. A higher ratio means the collection of receivables is efficient. Higher ratio is better

The ratio incresed from 2016 to 2017 . So ratio became better.

The ratio is greater than the industry average. So ratio is good comoared to industry average.

Average collection period

Average Collection period= 360/ receivables turnover

For 2016,   

Average collection period = 360/ 12.19

= 29.53

For 2017,

Average collection period = 360 / 12.77

= 28.19

The ratio indicates how many days are required to collect accounts receivables. The lesser the days the better.

The ratio decreased from 2016 to 2017. So ratio became better

The ratio is greater than the industry average of 22.10. The ratio is bad compared to industry average

Inventory turnover

Inventory turnover = Sales / Inventory

For 2016,

Inventory turnover = 975,000 / 110,000

= 8.86

For 2017,

Inventory turnover = 1,072,500 / 126,500

= 8.48

The ratio measures operational efficiency of the firm. It measures how many times the company sells its inventory and then replaces it. Higfher ratio means the company is able to sell the product quickly. So higher ratio is better.

The ratio decreases from 2016 to 2017. So it became worse.

The ratio is greater than the industry average. Hnce the ratio is good compared to indistry average.

Return on Equity

Return on equity = Net income / Stockholder's Equity

For 2016,

Return on Equity= 30,000 / 270,000

= 0.11

For 2017,

Return on Equity = 51,525/ 266,600

= 0.19

Return on Equity measure profitability to the equity shareholders. that is, how much profit is earned from every dollar of equity investment. The higher the ratio the better.

The ratio increased from 2016 to 2017. So it became better.

The ratio in 2017 is grater than the industry average. So ratio is good compared to industry average.

Times Interest earned

Times interest earned = EBIT / Interest Expense

where EBIT is the earnings before interest and taxes

For 2016,

Times interest earned = 75,000 / 25,000

= 3.00

For 2017,

Times Interest earned = 116,875 / 31,000

= 3.77

Times interest earned is the interest coverage ratio which measures the ability of the company to meet its interest payments. It indicates how many times the company can cover the interest payments using its earnings before interest and tax. the higher the ratio, the better the coverage.

The ratio increases from 2016 to 2017. So the ratio becomes better.

The ratio is much less than the industry average of 8.15. So the ratio is bad comoared to industry average.