Question

Selected information from the comparative financial statements of Emley Company for the year ended December 31,

                                                                                   2017 2016

Accounts receivable (net)                                 $180,000 $200,000

Inventory                                                                    140,000                 160,000

Total assets                                                             1,200,000                 800,000

Current liabilities                                                       140,000                 110,000

Long-term debt                                                          400,000                 300,000

Net credit sales                                                       1,330,000                 700,000

Cost of goods sold                                                     900,000                 530,000

Interest expense                                                           50,000                   25,000

Income tax expense                                                     60,000                   29,000

Net income                                                                 150,000                   85,000

Compute each of the following ratios and interpret the results:

1. Inventory turnover
2. Times interest earned
3. The debt to assets ratio
4. Accounts receivable turnover
5. Return on assets

Answer 1

i. Inventory turnover [Cost of goods sold/Average inventory] = 900000/((140000+160000)/2) =	6.00	The ratio tells that the inventory is turnover 6 times in a year. Another way to look at it is--Days' inventory outstanding [DIO of 365/60] is days, meaning that the stock of inventory represents 61 days requirement.
ii. Times interest earned [Operating income/Interest expense] = (1330000-900000)/50000 =	8.60	Indicates the number of times the interest expense can be paid from the operating income generated. A high ratio highlights the safety of the creditors.
iii. The debt to assets ratio [Total liabilities/Total assets] = (140000+400000)/1200000 =	45.00%	The ratio tells the % of assets financed by the debt. It highlights the risk presented by the borrowings.
iv. Accounts receivable turnover [Net credit sales/Average receivables] = 1330000/((180000+200000)/2) =	7.00	The ratio gives the number of times the receivables is turned over by credit sales during the period. From this ratio the Days' sales outstanding [DSO] is 52 days, which, means that the receivables outstanding represents 52 days credit sales. This has to be compared with the credit terms of the firm and with industry average.
v. Return on assets = Net income/Average total assets = 150000/((1200000+800000)/2) =	15.00%	The ratio says that the firm is earning a net return of 15% on the assets deployed. It can be compared with earlier figures or with industry standards.