Question

Using the formula sheet and Income Statement for FRS, solve the following ratios.  I have given you the interpretation of each ratio – in other words, what it’s purpose is and what it is telling you about the company’s performance.

FANCY RETAIL STORE, INC. (FRS) INCOME STATEMENT

For the Year Ended December 31, 20XX

Gross Sales                                                                             $500,000         

Less:    Sales Returns & Allowances   $8,000

            Sales Discounts                         5,000                 13,000

Net Sales Revenue                                                                              $487,000

Cost of Goods Sold

            Inventory, January 1, 20XX                                       $80,000

            Purchases                                            $200,000

            Less:    Purchase Returns/Allow.              1,000

                        Purchase Discounts                          500

            Net Purchases                                       198,500

            Plus:    Freight-In                                      2,500         201,000

            Goods Available for Sale                                            281,000

            Less:    Inventory, Dec. 31, 20XX                                65,000

            Cost of Goods Sold                                                                            216,000

Gross Margin                                                                                                  271,000

Operating Expenses

            Salaries                                                                        25,000

            Rent                                                                             25,000

            Depreciation                                                                  1,000

            Supplies                                                                        1,000

            Total Operating Expenses                                                                     52,000

            Operating Income                                                                                219,000

Other Revenue and (Expenses)

            Interest Revenue                                                          5,000                  5,000

            Income Before Tax                                                                              224,000

            Taxes (30%)                                                                                          67,200

Net Income                                                                                          $156,800

1.   Gross Margin Ratio

      Interpretation:  How much of each dollar is left after subtracting COGS from sales.  It is         

                                    your Gross Profit Margin before operating expenses have been deducted      

2.  Net Income Ratio

     Interpretation:  How much of each dollar earned by the company is pretax profit.     

                               Measures the profitability of your company and is used primarily internally

3.  Operating Expense Ratio

       Interpretation: a measure of your operational financial efficiency.  How much it costs to

       market or sell products vs. how much income they generate.  A cost/benefit analysis

4.  Returns and Allowances Ratio

Interpretation:  Can be a measure of customer dissatisfaction.  You need to determine the reason they are returning items.  Are your return policies too lenient?  Do you have low quality or obsolete products.  Compare year to year to make sure the rate isn’t increasing.  It also depends on the size of the retailer - A 2% return rate for Walmart is very acceptable but a 2% return rate for a small mom and pop operator will likely put them out of business.  

5.  Inventory Turnover Ratio

Interpretation:  Determines how often you are selling your total inventory annually.   A turn over rate of 2 times means that you are selling all of your inventory every 6 months.  Is this good?  Again, it depends on the business.  If you own a flower shop – this is terrible and you won’t stay in business.  However, if you own a high end jewelry store, this is probably acceptable.  If you need to boost your inventory turnover, then you will implement strategies such as price incentives to get people to buy more frequently.

6.  If FRS has a total invcstments of $1,000,000, then its Return on Investment is:

Interpretation:  You always want to have the highest ROI (profit margin) as possible, so this will influence your pricing strategies.  If FRS is a high end jewelry store, then they will increase ROI by charging higher prices because they have an inelastic consumer.  However, if they are a lower priced, higher volume jewelry store, then they can’t raise their prices, but must contain their costs because they have an elastic market demand or consumer.

Answer 1