Question

: The below table provides a partial Ratio Analysis of Jim’s Appliance Shop. Identify the trouble spots that the ratio analysis suggests and provide some insights on how these trouble spots can be corrected (give some specific suggestions).

Ratio                                      Jim’s Appliance Shop                      Industry Average

Current Ratio                                     1.70                                                        1.88                          

Debt Ratio                                           0.70:1                                                    0.73:1                   

Debt to Net Worth Ratio               2.70:1                                                    2.60:1   

Answer 1

Solution:-

Current ratio: Jim's Appliance Shop = 1.70, Industry average = 1.88 The current ratio is the ratio which gives the idea about liquidity and higher value is desirable. In this case, the company has a lower ratio than industry average so it is a cause for concern. Current ratio = Current Asset / current Liability and Current Asset has Cash, Account receivable, inventory etc. while current liability has Account payable, short-term loan, accrued expenses etc. So, in order to make this ratio better, the company needs to increase the current asset or decrease the current liability. So the company can reduce the account payable to look this ratio better.

Debt Ratio: Debt ratio is the ratio of debt o total asset (or debt + equity ) Debt ratio for the company is = 0.70:1 and while industry average is = 0.73:1. The lower debt ratio is desirable as compared to industry average as it shows that the company will not face any solvency issue.

Debt to Net Worth Ratio: Debt to equity or Debt to net worth ratio is the ratio that shows how much company has debt as compared to its equity and the lower value is desirable as compared to the industry average. In the given question the company has 2.70:1 while the industry average is 2.60:1. So the company has a higher ratio than the industry average and it is not desirable. So the company can make this ratio better by either reducing debt or increasing equity. Equity can be increased by increasing the retained earnings ( increase the profitability as net income after paying the dividends goes to retained earnings )