Question

In: Accounting

Explain the significance of the following ratiosReturn on AssetReturn on EquityNet income margin...

Explain the significance of the following ratios

Return on Asset

Return on Equity

Net income margin

book value

debit to equity

financial leverage

Solutions

Expert Solution

Significance of ratios

Return on Asset is also known as ROA. This is a profitability ratio and helps in assessing if the assets of the company are being utilised effectively to generate profits for the company. A higher ratio is always preferred.

Return on Equity is also known as ROE. This is another profitability ratio which helps in eveluating if the company is generating good returns for its shareholders or not. A higher ratio is always preferred.

Net income margin is also a profitability ration. This ratio shows amount of profit the company has been able to generate on $1 of its sales. Net income is arrived after all expenses and costs have been deducted from revenues and income the company generated during an accounting period.

Book Value is the difference between Total Assets and Total Liabilities and the balance between these two amounts is perceived to be the value of the firm. Hence, higher the book value more is the value of the company. This ratio comes in handy when a firm needs to be acquired or merged with another big firm. The promoters in such cases can get more value for their company if book value is high.

Debit to equity raito shows the proportion of external sources of funding (liabilities) versus the internal sources of funding (equity). A lower ratio is always preferred. A higher ratio means that the company has too much dependency on external borrowings which can impact the company adversely in the long run.

Financial Leverage shows how much proportion of the total assets are funded through external sources. The ratio helps in assessing if the company should raise funds through stockholders or borrow funds from bank/financial institutions to increase its total assets especially non-current assets.

Workings

Formulae to calculate these ratios are

Return on Asset = Net Income/Average Total Assets

Return on Equity = Net Income/Average Total Equity

Net income margin = = Net Income/Net Sales

Book Value = Assets - Liabilities

debit to equity = Total Liabilities/Total Equity

financial leverage = Total Liabilities/Total Assets

ekkarill92 answered 2 years ago
Next > < Previous

Related Solutions

Mastery Problem: Target Income and Margin of Safety Target Income and Margin of Safety At the...
Mastery Problem: Target Income and Margin of Safety Target Income and Margin of Safety At the break-even point, sales and costs are exactly equal. However, the goal of most companies is to make a profit. When a company decides that it wants to earn more than the break-even point of income, it must define the amount it thinks it will realistically make. By modifying the break-even equation, the sales required to earn a target or desired amount of profit may...
Mastery Problem: Target Income and Margin of Safety Target Income and Margin of Safety At the...
Mastery Problem: Target Income and Margin of Safety Target Income and Margin of Safety At the break-even point, sales and costs are exactly equal. However, the goal of most companies is to make a profit. When a company decides that it wants to earn more than the break-even point of income, it must define the amount it thinks it will realistically make. By modifying the break-even equation, the sales required to earn a target or desired amount of profit may...
Problem 21-1A Contribution margin income statement and contribution margin ratio LO A1 The following costs result...
Problem 21-1A Contribution margin income statement and contribution margin ratio LO A1 The following costs result from the production and sale of 4,150 drum sets manufactured by Tight Drums Company for the year ended December 31, 2017. The drum sets sell for $265 each. The company has a 40% income tax rate.    Variable production costs Plastic for casing $ 83,000 Wages of assembly workers 352,750 Drum stands 120,350 Variable selling costs Sales commissions 74,700 Fixed manufacturing costs Taxes on...
Problem 5-1A Contribution margin income statement and contribution margin ratio LO A1 The following costs result...
Problem 5-1A Contribution margin income statement and contribution margin ratio LO A1 The following costs result from the production and sale of 4,500 drum sets manufactured by Tight Drums Company for the year ended December 31, 2017. The drum sets sell for $300 each. The company has a 35% income tax rate.    Variable production costs Plastic for casing $ 121,500 Wages of assembly workers 414,000 Drum stands 162,000 Variable selling costs Sales commissions 112,500 Fixed manufacturing costs Taxes on...
compare between the revenue and margin performance, How have gross margin, operating margin, and net income...
compare between the revenue and margin performance, How have gross margin, operating margin, and net income developed in relation to the fluctuations in revenue? for both companies 1) Auto Wash Bot Ltd. Income Statement For the Year Ended December 31, 2015 Revenue $375,000 Cost of Goods Sold 86,250 Gross Profit 288,750 Other Expenses Advertising 35,400 Office Expense 22,750 Research 195,000 Wages and Salaries 40,000 Total Other Expenses 293,150 Income Before Taxes (4,400) Income Tax 0 Net Income $(4,400) 2) Popeye’s...
Multiple-Step Income Statement and Profit Margin The following income statement items, arranged in alphabetical order, are...
Multiple-Step Income Statement and Profit Margin The following income statement items, arranged in alphabetical order, are taken from the records of Shaw Corporation for the current year: Advertising expense $1,574 Interest expense $1,504 Commissions expense 2,316 Interest revenue 1,391 Cost of goods sold 29,210 Rent revenue 7,271 Depreciation expense - office building 3,088 Salaries and wages expense—office 11,357 Income tax expense 1,510 Sales revenue 48,053 Insurance expense - salesperson’s auto 2,142 Supplies expense—office 920 Required: Assume that Shaw Corporation classifies...
8. Hudson Co. reports the contribution margin income statement for 2019. HUDSON CO. Contribution Margin Income...
8. Hudson Co. reports the contribution margin income statement for 2019. HUDSON CO. Contribution Margin Income Statement For Year Ended December 31, 2019 Sales (10,300 units at $375 each) $ 3,862,500 Variable costs (10,300 units at $300 each) 3,090,000 Contribution margin 772,500 Fixed costs 600,000 Pretax income $ 172,500 1. Assume Hudson Co. has a target pretax income of $169,000 for 2020. What amount of sales (in dollars) is needed to produce this target income? 2. If Hudson achieves its...
Define each of the following terms and concepts and explain their significance in the economics of...
Define each of the following terms and concepts and explain their significance in the economics of natural resources. In your discussion of each term/concept, give relevant examples. [3 marks] Total willingness to pay [3 marks] Net present value [3 marks] Social costs [3 marks] Efficiency [3 marks] Private good [3 marks] Market failure [3 marks] Discounting
Define each of the following terms and concepts and explain their significance in the economics of...
Define each of the following terms and concepts and explain their significance in the economics of natural resources. In your discussion of each term/concept, give relevant examples. a. [3 marks] Natural resource rents b. [3 marks] Public good c. [3 marks] intertemporal efficiency d. [3 marks] Nonrenewable resources e. [3 marks] Maximum sustainable yield f. [3 marks] Incentive-based policies
Differentiate between public and private savings using the national income accounts equation and explain the significance...
Differentiate between public and private savings using the national income accounts equation and explain the significance of each type of savings. Use the loanable funds market diagram to show what happens to interest rate and quantity of loanable funds if government revenues exceed its spending? Explain why it is important for a nation to increase savings? Label the diagram completely. You can draw the graph with a pen and insert a picture here.
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT