Question

P3-25: Integrative: Complete ratio analysis Given the following financial statements, historical ratios, and industry averages, calculate Sterling Company’s financial ratios for the most recent year. (Assume a 365-day year.)

Sales revenue	$10,000,000
Less: Cost of goods sold	7,500,000
Gross profits	$ 2,500,000
Less: Operating expenses
Selling expense	$   300,000
General and administrative expenses	650,000
Lease expense	50,000
Depreciation expense	200,000
Total operating expense	$  1,200,000
Operating profits	$  1,300,000
Less: Interest expense	200,000
Net profits before taxes	$  1,100,000
Less: Taxes (rate = 21%)	231,000
Net profits after taxes	$     869,000
Less: Preferred stock dividends	50,000
Earnings available for common stockholders	$     819,000
Earnings per share (EPS)	$4.10
Sterling Company Income Statement for the Year Ended December 31, 2019

Assets		Liabilities and Stockholders’ Equity
Cash	$   200,000	Accounts payablea	$  900,000
Marketable securities	50,000	Notes payable	200,000
Accounts receivable	800,000	Accruals	100,000
Inventories	950,000	Total current liabilities	$ 1,200,000
Total current assets	$ 2,000,000	Long-term debt (includes financial leases)	$ 3,000,000
Gross fixed assets (at cost)	$12,000,000
Less: Accumulated depreciation	3,000,000	Preferred stock (25,000 shares, $2 dividend)	$ 1,000,000
Net fixed assets	$ 9,000,000
Other assets	1,000,000	Common stock (200,000 shares at $3 par)b	600,000
Total assets	$12,000,000	Paid-in capital in excess of par value	5,200,000
		Retained earnings	1,000,000
		Total stockholders’ equity	$ 7,800,000
		Total liabilities and stockholders’ equity	$12,000,000
Sterling Company Balance Sheet December 31, 2019

Analyze its overall financial situation from both a cross-sectional and a time-series viewpoint. Break your analysis into evaluations of the firm’s liquidity, activity, debt, profitability, and market.

Ratio	Actual 2017	Actual 2018	Industry average, 2019
Current ratio	1.40	1.55	1.85
Quick ratio	1.00	0.92	1.05
Inventory turnover	9.52	9.21	8.60
Average collection period	45.6 days	36.9 days	35.5 days
Average payment period	59.3 days	61.6 days	46.4 days
Total asset turnover	0.74	0.80	0.74
Debt ratio	0.20	0.20	0.30
Times interest earned ratio	8.2	7.3	8.0
Fixed-payment coverage ratio	4.5	4.2	4.2
Gross profit margin	0.30	0.27	0.25
Operating profit margin	0.12	0.12	0.10
Net profit margin	0.062	0.062	0.053
Return on total assets (ROA)	0.045	0.050	0.040
Return on common equity (ROE)	0.061	0.067	0.066
Earnings per share (EPS)	$1.75	$2.20	$1.50
Price/earnings (P/E) ratio	12.0	10.5	11.2
Market/book (M/B) ratio	1.20	1.05	1.10
Historical and Industry Average Ratios for Sterling Company

Answer 1

Profitability Ratios:

Return on Equity(%)= (Earning after tax/(stockholder equity))
For 2019 : (610000/(7800000))=7.82%

Return on total Assets(%)= Earning after tax/ totalAssets
For 2019: (610000/12000000)=5.08%

net Profit margin(%)=( Earning after tax/Net sales)
For 2019: (610000/100000000)=6.1%

Gross margin(%)=(gross profit/sales)
For 2019: (2500000/100000000)=25%

Operating Profit margin(%)=( Operating Profit/Net sales)
For 2019: (1300000/100000000)=13%

Valuation:

Price/earnings ratio= market price per share/Earning per share
for 2019=39.5/3.05=12.06

MArket to book ratio= market price per share/book value per share
for 2019=39.5/(7,800,000/(3.05*610,000))=4.19

Asset Turnover:

Fixed assets Turnover= (Net sales/ Assets)
For 2019 :(100000000/12000000)=0.833

Inventory Turnover= (COGS/inventory)
For 2019 :(7500000/950,000)=7.89

Collection Period= 365*(Account Receivable/ sales)
For 2019: (365*800,000/100000000)=29.2 days

Payable period= 365*(Account payable/Sales)
For 2019: (365*900,000/100000000)=32.85 days

Leverage and Liquidity Ratio:

Debts ratio= ((Current Liablities+Long term debt)/ total assets)
For 2019: (4,200,000)/12,000,000=0.35

Total interest earned rati0 =EBIT/Interest
For 2019=1,300,000/200,000=6.5

Current Ratio= Current assets/current liabilty
For 2019: (2,000,000/1,200,000)=1.67

Quick ratio= (Current assets-inventory)/current liabilty
For 2019: (2,000,000-950,000)//1,200,000)=0.875