Question

Below is selected financial information from the financial statements of company A and company B. Both company A and company B started their business on 1/1/2019.

	Company A	Company B
current assets on 12/31/2019	100	8,000
total assets on 12/31/2019	11,000	28,000
current liability on 12/31/2019	200	4,000
total liability on 12/31/2019	4,000	18,000
sales revenue on 12/31/2019	4,500	20,000
Cost of goods sold for year 2019	1,000	16,000
interest expense for year 2019	400	1,000
net income for year 2019	1,500	2,500

a) Which company provides better return on assets?

b) Which company has less liquidity risk in terms of current ratio?

c) Which company has less solvency risk in terms of debt to total assets ratio?

Answer 1

The return on asset of company A = Net income / Average total assets

= 1,500 / 11,000

= 13.63%

The current ratio of company A = Current assets / Current liabilities

= 100/200

= 0.5

The debt to total assets ratio of company A = Total liabilities / Total assets

= 4,000/11,000

= 36.36%

The return on asset of company B = Net income / Average total assets

= 2,500/28,000

= 8.92%

The current ratio of company B = Current assets / Current liabilities

= 8,000/4,000

= 2

The debt to total assets ratio of company B = Total liabilities / Total assets

= 18,000/28,000

= 64.28%

a) Company A provides a better return on assets which is 13.63%.

b) Company B has less liquidity risk as it has a higher current ratio which is 2.

c) Company A has less solvency risk as debt to total asset ratio is 36.36% which is good for the company.