Question

Analyze the firm's liquidity, leverage, turnover, and profitability using ratio analysis.

Answer 1

liquidity ratio :

current ratio : current assets / current liabilities

quick ratio : cash + marketable securities + short term investments + account receivables /current liabilities

quick ratio does not include inventory, since inventory is not easily converted to cash.

for example : current assets: $50,000

current liabilities: $25,000

therefore, the current ratio is 2:1. a current ratio os 2 or greater than 2 means that the company is in a better position to pay off the liabilities.

leverage ratio : total debt/ total equity

the debt equity ratio should be low, a high debt equity ratio means its bad for the financial health of the business ,too much interest payments may pose a threat of default or bankruptcy in the business.

the equity multiplier : total assets /equity ,is a component of the ROE, it measures financial leverage that is proportion of debt in the capital structure.

turnover ratios :

asset turnover ratio :sales/ average total assets , measures the value of the company's sales in relation to the assets .

how efficiently the company is using its assets to generate sales.

inventory turnover ratio : COGS/average inventory

COGS : cost of goods sold.

average inventory = ending inventory + beginning inventory/2

using sales instead of COGS inflates the inventory turnover ratio.

COGS = $2,50,000

average inventory :$25,000

inventory turnover is 10

dividing this by 365/10 = 36.5 so the inventory turns over 10 times and is hand for approximately 36 days.

profitability ratios:

net profit margin:net income/sales

gross profit margin : gross profit/sales

for example gross profit : $30,000

sales :3,00,000

therefore, the gross profit margin is 10%.

return on assets : net income/ assets

net income = $5,000

assets = $75,000

therefore, net income on assets 6.67%

return on equity : net income/equity

for example the net income in a company is $5,000 and the equity comprising of common stock and retained earnings is the portion of equity which is 55,000

5,000/55,000 * 100 = 9.09%

operating margin : operating profit/ sales

these ratios measures the profitability of the business. profit is what is left over after paying for all the expenses operating and non operating expenses. the higher the profitability the better is the performance of that company.