Question

Selected ratios for 2018 for two companies in the same industry are presented below:

Ratio	Potter	Draco	Industry Average
Asset turnover	2.7x	2.3x	2.5x
Average collection period	31 days	35 days	38 days
Basic Earnings per share	$2.75	$1.25	Not available
Current Ratio	1:9:1	3:0:1	1:8:1
Dividend yield	0.3%	0.1%	0.2%
Debt to total assets	48%	32%	45%
Gross profit margin	30%	34%	33%
Inventory turnover	10x	7x	8x
Payout ratio	9%	19%	14%
Price-earnings ratio	29x	45x	38x
Profit margin	8%	6%	5%
Return on assets	12%	10%	10%
Return on common shareholders' equity	24%	16%	18%
Time interest earned	5.2x	7.6x	7.2x

REQUIRED: Answer each of the following questions providing the ratio(s) to support your answer, explain.

1) Comment on how successful each company appears to managing its accounts receivable. Terms are net 30 for both companies
2) How well does each company appear to be managing its inventory?
3) Which company is more solvent, explain using ratios?  
4) Which company is more profitable, explain using ratios?
5) The gross profit margin for Draco is higher than Potter's and the industry average. Provide two reasons why this would be the case?
6) Which company would investors believe would have greater prospects for seeking growth?
7) Why is Basic Earnings per Share not comparable between companies?

Answer 1

1) Both the companies are managing their accounts receivable well as the average collection period for company Potter is 31 days and Darco 35 days which is less than industry average. Potters collection period is almost same as of their terms of 30 days and Darco is also not far behind.

2) Company Potter is seemingly managing its inventory well as they are able to convert their inventory into sales quickly than Company Darco as Potters Inventory Turnover is 10x which is higher than that of Darco of 7 days.

3) Company Darco is more solvent as it has higher current ratio meaning more current assets. Current Ratio of Darco is 3:1 which is significantly higher than that of Potters of 1.9: 1

4) Since the Profit Margin of Company Potter is higher than profit Margin of Company Darco, company Potter is more profitable. As they are able to earn more for the sales made.

5) The Gross Margin Ratio of company Potter is higher than that of Company Potter and industry average, following might be the reasons for it.
Sales Price for the product might be higher
Direct Costs associated with the product might be lower i.e. They might be able to buy material at cheap rates and higher labor at lower rates.

6) Investors would believe that the Company Darco would have greater prospects for seeking growth because PE Ratio of Company Darco is higher than that of Company Potter and Industry average, moreover the Company Darco has higher Times Interest Ratio which depicts that company Darco is earning significantly higher to cover its interest expenses.

7) Basic EPS is not comparable between companies as it does not take effect of shares that are to be issued in future against convertible preference shares, convertible debentures, employee stock options etc