Question

Calculate the following ratios and comment if the ratio is favorable or unfavorable. All amounts listed are correct and don’t worry if some of the ratios look out of sync, they are intentional.

a. Company 1 current assets are $500,000 and current liabilities are $325,000.

b. Company 2-Cash and cash equivalents are $100,000, net receivables are $250,000 and current liabilities are $300,000

c. Company 3-total liabilities are $750,000 and the balance in the unrestricted Fund Balance is $850,000

d. Company 4- Operating loss of $125,000 and total operating revenue is $6,000,000

e. Company 5 EBIT is $600,000 and total assets are $4,250,000

Answer 1

a. Current ratio=Current assets/Current Liabilities

ie. 500000/325000=

1.54

Current assets are 1.5 times, the current laibilities

Ideal current ratio is 2 times . So.the ratio is unfavourable.

b.Quick or Acid test ratio= (Cash& cash equivalents+Receivables)/Current liabilities

ie. (100000+250000)/300000=

1.17

Quick assets are 1.17 times, the current laibilities

Ideal Quick ratio is 1 time . So.the ratio is favourable.

c.Total liabilities/Unrestricted fund balance =

750000/850000=

0.88

Total liabilities works out to 88% of the total funds available , to meet any exigencies.

Normally, outside liabilities can be 1.5 times or maximum 2 times , the internal funds--to take maximum advantage of interest expenses & the associated tax -shields.

Cost of own funds is more than the cost of borrowed funds , as the former are after-tax amounts re-invested /retained in the business.

Hence, the above indicates lack of proper investments of own funds ,ie.idling of funds & hence

Unfavourable.

d.Operating profit margin= Net operating profit/Operating revenues=

-125000/6000000=

-2.08%

It's loss making & hence

Unfavourable

e. EBIT is Operating profit/return

so,Operating Return on total assets=EBIT/Total assets

ie. 600000/4250000=

14.12%

This ratio measures the efficiency with which the total assets are used in the core business operations , before being impacted by non-operating items like interest expenses.

A return of $ 14 for $ 100 invested , looks favourable.

But this needs comparison with peers in the industry or previous year's figures , to say for certain.

Also much depends on the rest non-operating items , to know what is going to net.